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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, 10 May 2017.
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May 10, 2017 Bank of Japan Outlook for Economic Activity and Prices and Monetary Policy Speech at a Meeting Held by the Naigai Josei Chosa Kai (Research Institute of Japan) in Tokyo Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) 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 (MPM) held at the end of April, the Bank formulated its projections for Japan's economic activity and prices as well as risk factors through fiscal 2019, and released them in the Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to talk 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 Report. I. Current Situation of Japan's Economic Activity and Its Outlook Stronger Global Economic Growth Momentum Let me start by talking about global economic developments. In the first half of 2016, pessimistic views about the global economy prevailed amid turbulence in global financial markets against the background of the slowdown in emerging economies and uncertainties regarding those economies. With the benefit of hindsight, however, it appears that the global economy hit bottom in the first half of 2016. Since mid-2016, the global economy has continued to improve steadily, and its growth momentum now seems to be strengthening further. In particular, a global improvement in the manufacturing sector and trade activity has become clear. For example, an indicator of the overall business conditions in the manufacturing sector has continued on an improving trend in advanced economies as well as emerging and commodity-exporting economies (Chart 1). In addition, with regard to the world trade volume -- calculated by adding up imports in each country -- a pick-up in the trade volumes has been spreading globally, mainly for Asia and the United States (Chart 2). The world trade volume had tended to grow at a slower pace than world economic growth for a long period since the global financial crisis, and such deceleration in growth of the world trade volume is called "slow trade." As regards the background to this, structural factors such as a pause in the expansion of the global supply chain have been pointed out, in addition to a cyclical decline in demand. The recent global improvement in the manufacturing sector and trade activity draws attention as this may suggest a change is finally taking place from such slow trade. The World Economic Outlook (WEO) released by the International Monetary Fund (IMF) last month also projects that the global economic growth rate will gradually increase, registering 3.1 percent in 2016, 3.5 percent in 2017, and 3.6 percent in 2018. Current Situation of Japan's Economic Activity Reflecting such improvement in the global economy, the economic growth in Japan has taken hold more firmly. While the Bank had previously assessed that the economy had "continued its moderate recovery trend," the assessment was revised upward in the April 2017 Outlook Report, describing the economy as "having been turning toward a moderate expansion." This is based on the fact that, with the virtuous cycle led by exports and production becoming firmer, the output gap -- which shows the utilization of capital and labor and is defined such that its long-term average is 0 percent -- has turned positive (Chart 3). Let me elaborate on this point. In the corporate sector, exports and production have been on an increasing trend, mainly on the back of the cyclical improvement in the manufacturing sector on a global basis led by IT-related industries, as well as inventory and capital stock adjustments progressing in emerging economies (Chart 4). In this situation, corporate profits have been improving and the ratio of current profits to sales for all industries and enterprises for the October-December quarter of 2016 marked record profits (Chart 5). The March 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) suggested that business sentiment has improved in a wider range of industries. Under such circumstances, business fixed investment has been on a moderate increasing trend. Improvements also have been observed in the household sector. The employment and income situation has continued to improve steadily. The active job openings-to-applicants ratio is almost comparable to the peak level observed during the "asset bubble" period, with the latest figure being 1.45 times, and a perception of labor shortage suggested by the diffusion index (DI) for employment conditions in the March Tankan has heightened further (Chart 6). The unemployment rate has declined to the range of 2.5-3.0 percent recently, which is virtually full employment. Under such tightening of labor market conditions, wages have been rising moderately (Chart 7). In particular, the year-on-year rate of increase in hourly cash earnings of part-time employees, which are responsive to labor market conditions, has accelerated, being at around 2 percent of late. As for scheduled cash earnings of full-time employees, many firms are expected to raise their base pay for the fourth consecutive year in the annual spring labor-management wage negotiations this year. Base pay rises are especially evident this year in small and medium-sized firms that face higher labor shortages. Against the background of such improvement in the employment and income situation, private consumption has been resilient. Although relatively weak developments had been seen in some of its indicators in the first half of 2016, it has picked up thereafter, due mainly to an improvement in consumer sentiment. The Consumption Activity Index (CAI) -- which the Bank calculates by combining various sales and supply-side statistics -- has followed a moderate increasing trend since the second half of 2016 (Chart 8). Outlook for Japan's Economic Activity With regard to the outlook, Japan's economy is likely to continue its moderate expansion. Specifically, with the growth rates in overseas economies increasing moderately, a virtuous cycle from income to spending is likely to be 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. Under such circumstances, the economy is likely to continue expanding and maintain growth at a pace above its potential, mainly through fiscal 2018. At present, Japan's potential growth rate as estimated by the Bank is in the range of 0.5-1.0 percent; the medians of the Policy Board members' forecasts of the growth rates for fiscal 2017 and 2018 were 1.6 percent and 1.3 percent, respectively (Chart 9). These projections are more or less unchanged from those presented in the January 2017 Outlook Report. In fiscal 2019, for which the outlook was newly formulated in the latest Outlook Report, the growth pace is projected to decelerate, although the economy is expected to continue expanding. The first reason for the forecast concerns cyclical adjustments in capital stock. That is, the current economic expansion phase has been continuing since end-2012, and it would have lasted for a considerably long period by fiscal 2019. Considering the business cycle, therefore, business fixed investment in particular is likely to decelerate. Furthermore, peaking out of the Olympic Games-related demand would also exert an impact on the cyclical adjustments. The second reason is the scheduled consumption tax hike. In the April 2017 Outlook Report, economic projections were formulated based on the assumption that the consumption tax will be raised to 10 percent in October 2019 pursuant to the provisions of the law. The scheduled consumption tax hike will affect the growth rates through the following two channels: (1) the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike and (2) the effects of a decline in real income. The negative impact of the consumption tax hike on the projected growth rate for fiscal 2019 is expected to be smaller than that on the rate for fiscal 2014, when the last tax hike took place, mainly because the increase in the consumption tax rate is smaller than that of the previous tax hike and a reduced tax rate will be applied to such items as food and beverages. However, it should be noted that the impact of the consumption tax hike is highly uncertain and varies depending, for example, on the income situation and price developments. The impact of the next tax hike in particular should be regarded as being subject to a considerable margin of error because it is scheduled to take place as far off as two and a half years from now. II. Current Situation of Prices and Their Outlook Current Situation of Prices Next, I will talk about price developments. Since the second half of 2014, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food had remained under downward pressure stemming from the decline in crude oil prices; however, with energy prices now starting to exert upward pressure on general prices, the rate of change turned positive in January 2017 for the first time in 13 months. Meanwhile, looking at the year-on-year rate of change in the CPI excluding fresh food and energy, while this had been in negative territory before the introduction of quantitative and qualitative monetary easing (QQE) in April 2013, it turned positive in autumn 2013. Thereafter, the rate of change has been positive as a trend for more than three years (Chart 10). Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in prices. Nevertheless, the year-on-year rate of increase in the CPI excluding 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. Some weakness in the CPI observed last year appears to have been affected by firms' cautious price-setting stance against the background of relatively weak private consumption and by the appreciation of the yen. In recent months, the reduction in prices of and charges for mobile phones has exerted a considerable impact on the CPI. Such temporary developments in specific sectors should be considered separately from the underlying trend in inflation. However, looking at the CPI as a whole, it is also true that the inflation momentum is not yet sufficiently firm. Meanwhile, inflation expectations also have remained in a weakening phase. Various market indicators and survey results indicate that inflation expectations have not yet picked up clearly on the whole, although some of them show a rise in such expectations. Momentum toward Achieving the Price Stability Target of 2 Percent As I have explained, there is some contrast observed between recent economic activity and prices, in that the real economy has been improving steadily, whereas price developments have remained sluggish thus far. However, we believe that the momentum toward achieving the price stability target of 2 percent has been maintained firmly and the year-on-year rate of change in the CPI excluding fresh food is likely to increase toward 2 percent. Specifically, we expect the following mechanism for higher inflation going forward. First, further improvement in the output gap, mainly on the back of further tightening of labor market conditions, will lead to a rise in the inflation rate through wage increases. Second, energy prices will push up the CPI and their contribution to it will increase through the second half of 2017. Third, with these factors pushing up actual inflation rates, inflation expectations are expected to rise accordingly, leading to an increase in the underlying trend in inflation. Let me elaborate on this mechanism. Recently, more firms are taking initiatives to improve working conditions, including wages, in order to address increased demand and labor shortage. Looking at historical developments, there has been a stable relationship observed between the CPI and hourly nominal wages in Japan, where their rates of increase move almost in parallel. In fact, prices of goods and services have been increasing steadily. The Bank aims at a moderate rise in the CPI inflation accompanied by a rise in corporate profits and wages, and these developments are exactly what we expect. However, it is also true that wage increases are relatively moderate despite the tightening of labor market conditions and a rise in corporate profits. One of the reasons behind this is that, after having experienced protracted deflation, the mindset and behavior based on the assumption that prices will not increase have been deeply entrenched among the public. For instance, in the annual spring labor-management wage negotiations, a base pay rise is usually negotiated based on the previous fiscal year's inflation rate. Some firms have started to cut back their services in response to a rise in labor costs in real terms due to wage increases and a reduction in hours worked, instead of raising prices of their goods and services. This is another example of the persistent deflationary mindset. It is not easy to dispel this mindset. That said, the environment surrounding wages and inflation has been improving steadily, albeit at a moderate pace. It is important to ensure that this positive trend continues going forward. Medium- to long-term inflation expectations -- that is, people's perception of future price developments -- are a crucial factor that determines the inflation rate from a relatively long-term perspective. As pointed out in the Bank's Comprehensive Assessment released in September 2016, inflation expectations going forward in Japan tend to be largely affected by actual inflation rates. This tendency is described as the inflation expectation formation being largely "adaptive," in somewhat technical terms. Since summer 2015, inflation expectations have been in a weakening phase, and this is mainly attributable to the fact that actual inflation rates had declined against the backdrop of a fall in crude oil prices and the headwinds for the global economy, which I mentioned at the outset. However, going forward, this mechanism is expected to work in the opposite direction. That is, if actual inflation rates rise on the back of increases in wages and energy prices, this rise will lead to an increase in inflation expectations, through the adaptive mechanism. The Bank aims to eventually achieve a situation where people's inflation expectations are firmly anchored at 2 percent even if actual inflation rates fluctuate due to various factors. In order to achieve that situation, however, actual inflation rates need to be raised first. While an increase in the CPI due to energy prices is transitory, this rise will work as a driving force for raising inflation expectations. Against this background, 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 April 2017 Outlook Report are 1.4 percent for fiscal 2017, 1.7 percent for fiscal 2018, and, on a basis excluding the direct effects of the scheduled consumption tax hike, 1.9 percent for fiscal 2019 (Chart 9). The forecasts through fiscal 2018 are more or less unchanged from those presented in the January Outlook Report. The timing of the rate of change in the CPI reaching around 2 percent will likely be around fiscal 2018, which also is unchanged from the previous Outlook Report. In fiscal 2019, the rate of change is expected to remain at around 2 percent as inflation expectations rise. III. Risk Factors for Economic Activity and Prices Going Forward There are upside and downside risk factors to the baseline scenario for economic activity and prices that I have explained thus far. Next, I would like to talk about the major risk factors. The largest risk factor for economic activity is developments in overseas economies. While it is true that the global economic growth momentum has been increasing, uncertainties regarding future developments have remained high. In particular, the U.S. economic policies and their impact on global financial markets warrant attention. The U.S. government has released the tax reform plan recently; it is necessary to carefully monitor how the specifics of its economic policies as a whole and its initiatives toward implementing these policies will play out. With regard to developments in the financial markets, stock prices and the long-term interest rate have risen significantly since last autumn on the back of expectations for the new administration's aggressive policy conduct. In the meantime, there was a phase where they declined somewhat amid uncertainties regarding its economic policies. Since the U.S. economic policies can largely affect not only its economy but also the global economy and financial markets, the new administration's policy direction and its effects warrant careful attention. In Europe, there are noticeable risk factors such as (1) national elections scheduled to be held in some major economies, in addition to the presidential election held recently in France, (2) negotiations on the United Kingdom's exit from the European Union (EU) and their effects, and (3) prospects regarding the European debt problem, including the financial sector. In addition, developments in emerging and commodity-exporting economies as well as various geopolitical risks are uncertain. It is therefore necessary to continue to pay close attention to the possibility that these risk factors will affect the economy through volatility in global financial markets and possible deteriorations in people's sentiment. On the other hand, we also should keep in mind that, given that market participants and economic entities already factor these risks in to a certain extent, the economy could deviate upward from the baseline scenario through a rise in sentiment depending on how they play out. In addition to the risks mentioned earlier, developments in firms' and households' mediumto long-term inflation expectations warrant due attention as they would directly affect inflation going forward. While we expect that inflation expectations are likely to follow an increasing trend, given that actual inflation rates have been somewhat weak recently, uncertainty remains regarding the momentum to push up inflation expectations through the "adaptive expectation formation mechanism." In the baseline scenario, firms' price- and wage-setting stance is expected to become more positive as inflation expectations increase. However, it should be noted that their price- and wage-setting stance could remain more cautious than the baseline scenario, depending on developments in inflation expectations. IV. The Bank's Conduct of Monetary Policy Lastly, I would like to touch upon the thinking behind 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 new framework consists of two components (Chart 11). The first 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 actual 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 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 is yield curve control. This aims to seek a decline in real interest rates, which has been the main transmission mechanism of policy effects since the introduction of QQE, by controlling short- and long-term interest rates. Under yield curve control, the Bank has been facilitating the formation of the 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. 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. Almost eight months have passed since the Bank introduced "QQE with Yield Curve Control." Under this framework, the yield curve has been formed smoothly in a manner consistent with the guideline for market operations. Against this background, financial conditions have been highly accommodative. The year-on-year rate of increase in the amount outstanding of bank lending has been accelerating to around 3 percent recently, on the back of increases in demand for funds related to mergers and acquisitions and in those for business fixed investment. As this indicates, the monetary easing effects have prevailed steadily. As I explained earlier, although the economic growth in Japan has taken hold more firmly, there is still a long way to go to achieve the price stability target of 2 percent, and the inflation momentum is not yet sufficiently firm. Risks have continued to be skewed to the downside, particularly those regarding developments in overseas economies and in firms' and households' medium- to long-term inflation expectations. Under these circumstances, I believe it is of utmost importance that the Bank maintain the current guideline for market operations and persistently pursue powerful monetary easing. Meanwhile, as I have stated repeatedly, the Bank's JGB purchases are conducted to achieve the target level of interest rates specified by the guideline for market operations decided at each MPM. The actual conduct of JGB purchases is, in that regard, determined practically. 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. With regard to the future conduct of monetary policy, the Bank decides the guideline for market operations at each MPM with a view to facilitating 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. In this regard, as the global interest rate environment is changing in response to the pick-up in global growth momentum and the Federal Reserve proceeding with the policy rate hikes, some argue that the Bank should take these changes into account in conducting its monetary policy. It should be noted, however, that each central bank pursues monetary policy with the aim of achieving their domestic mandate of supporting economic activity and ensuring price stability. Since the conduct of monetary policy depends on their own economic and price developments, it is natural that there is a divergence in their policy directions reflecting differences in the underlying economic conditions and inflation. The Bank will continue to conduct monetary policy in an appropriate manner, taking into account domestic economic and price developments, in order to achieve the price stability target of 2 percent at the earliest possible time. Conclusion Four years have passed since the Bank introduced QQE in April 2013. In the meantime, Japan's economic activity and prices have improved significantly. Although it is taking a long time to change the deflationary mindset that has been entrenched among the public for many years, the situation is improving steadily toward achieving the price stability target of 2 percent. What is of utmost importance is to continue with monetary easing until the Bank achieves the 2 percent target. The current policy framework -- "QQE with Yield Curve Control" -- is a highly sustainable framework that is designed to enable the Bank to take flexible responses to address various changes in the situation. The Bank will achieve the price stability target of 2 percent by persistently pursuing powerful monetary easing under this framework. Thank you. Outlook for Economic Activity and Prices and Monetary Policy Speech at a Meeting Held by the Naigai Josei Chosa Kai (Research Institute of Japan) in Tokyo May 10, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 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 2 World Trade Volume y/y % chg. y/y % chg. Trade volume (real imports) Real GDP -5 -10 -15 Trade volume (real imports) -20 CY 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Notes: 1. Figures for 2017/Q1 are January-February averages. Notes: 2. Real GDP for the world economy is calculated by the International Department of the Bank of Japan based on IMF data and national and regional GDP growth rates. Sources: CPB Netherlands Bureau for Economic Policy Analysis; IMF, etc. Chart 3 Output Gap % -2 -4 -6 -8 CY01 Note: The output gap is estimated by the Research and Statistics Department, Bank of Japan. For the details on the estimation methods, please refer to the forthcoming Bank’s research paper "Methodology for Estimating Output Gap and Potential Growth Rate: An Update." Sources: Cabinet Office; Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Ministry of Economy, Trade and Industry; Research Institute of Economy, Trade and Industry. Chart 4 Exports and Industrial Production s.a. Real exports(CY 2015=100) Industrial production(CY 2010=100) CY 10 Sources: Bank of Japan; Ministry of Finance; Ministry of Economy, Trade and Industry. Chart 5 Corporate Profits s.a., % Ratio of current profits to sales (all industries and enterprises) CY 01 Note: Based on the "Financial Statements Statistics of Corporations by Industry, Quarterly." Excluding "Finance and Insurance." Source: Ministry of Finance. Chart 6 Labor Market Conditions Unemployment Rate and Active Job Openings-to-Applicants Ratio s.a., times s.a., % Unemployment rate (left scale) Active job openings-to-applicants ratio (right scale) Tankan: Employment Conditions DI 1.5 -30 1.4 -25 1.3 -20 1.2 1.1 reversed, DI ("excessive" - "insufficient"), % points All enterprises Large enterprises Small enterprises -15 -10 1.0 -5 "Insufficient" 0.9 0.8 0.7 CY05 "Excessive" 0.6 0.5 0.4 0.3 CY 05 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bank of Japan. Chart 7 Wages Hourly Cash Earnings 2.5 Employee Income y/y % chg. y/y % chg. Hourly cash earnings 2.0 Hourly scheduled cash earnings (part-time employees) 1.5 1.0 0.5 0.0 -0.5 -1.0 Number of employees -1 Total cash earnings -1.5 Employee income -2 -2.0 Note: Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures for 2017/Q1 are those of March. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 8 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 9 Outlook for Economic Activity and Prices (as of April 2017) y/y % chg. Real GDP Fiscal 2017 Forecasts made in January 2017 Fiscal 2018 Forecasts made in January 2017 Fiscal 2019 CPI (all items less fresh food) +1.6 +1.4 +1.5 +1.5 +1.3 +1.7 +1.1 +1.7 +0.7 +1.9 Note: Figures indicate the median of the Policy Board members’ forecasts (point estimates). Figures for the CPI (all items less fresh food) exclude the effects of the consumption tax hikes. Source: Bank of Japan. Chart 10 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 11 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 2% 0.6 0.4 Target level of the long-term interest rate "around zero percent" Short-term policy interest rate "minus 0.1 percent" 0.2 0.0 -0.2 -0.4 Expansion of monetary base continues Source: Bloomberg. 0 1 year 9 10 15 20 Residual maturity
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a reception to celebrate the 30th anniversary of the Bundesbank's Representative Office, Tokyo, 22 May 2017.
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Haruhiko Kuroda: The virtues of international cooperation among central banks Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a reception to celebrate the 30th anniversary of the Bundesbank’s Representative Office, Tokyo, 22 May 2017. * * * Good evening, Ladies and Gentlemen. It is a great honor to be invited to this reception celebrating the 30th anniversary of the Deutsche Bundesbank in Tokyo. I would like to extend my sincere congratulations to Dr. Dombret, Executive Board Member of the Bundesbank, Ms. Moede, Representative of the Tokyo office, and other staff members of the Bundesbank. Throughout these 30 years, the Bundesbank has positioned its Tokyo office as the hub for its activities in Asia, and has shown its strong commitment to Japan. I would like to highlight in particular, the expansion of the functions of the Tokyo office with the establishment of a trading office in 2012, just one year after the tragic Great East Japan Earthquake. Looking around at all the faces gathered here to celebrate this anniversary event, I must commend the Bundesbank Tokyo office on their great success in establishing a deep and extensive network in the local community. Over the past 30 years, there have been significant advancements in the global economy. The growth rate of trade volume, which until the 1980s followed a similar rate to real GDP, significantly outpaced real GDP from the 1990s to the mid-2000s. One of the contributing factors was the expansion of global value chains from the late 1980s with the end of the Cold War, when large amounts of direct investment began to flow into countries of the Eastern bloc, such as China, the member states of the former Soviet Union, and Eastern Europe, as they entered into the global economy. Both Germany and Japan played pivotal roles in this new wave of globalization. The advancement of globalization over the years has brought about stronger relationships among countries and regions, both economically and financially. On the other side of the picture, as evident in the case of the Asian currency crisis 20 years ago or the global financial crisis that erupted 10 years ago, negative shocks are more likely to transcend national borders. In this situation, international cooperation among central banks has become ever more important. In terms of the relationship between Germany and Japan, the Bank of Japan established a representative office in Frankfurt in 1956. Making the most of the representative offices in each other’s countries, the Deutsche Bundesbank and the Bank of Japan have always enjoyed the timely, candid, and fruitful exchange of information and views, notwithstanding the geographical distance between the two countries. Dr. Dombret, who is with us today, is the Executive Director for International Relations. Tonight, I want to mention another of his many important roles, as “Head of the Money Museum.” The Deutsche Bundesbank refurbished its Money Museum last December. Unfortunately, I have not yet had the chance to visit the museum myself, but according to our staff at our representative office in Frankfurt, the new Museum offers a number of innovative displays that captivate visitors. They have told me that the displays show the Bundesbank’s deep-rooted belief that “Geld ist Vertrauenssache,” or “money is a matter of trust,” in other words, its strong commitment to price stability. The environment surrounding central banks is forever changing. Nevertheless, one thing I am sure will never change is that our two banks will continue to work closely together to fulfil our 1/2 BIS central bankers' speeches common mission of achieving price stability. I would like to close my remarks with the heartfelt wish for continued friendship and cooperation between the Deutsche Bundesbank and the Bank of Japan, as well as between Germany and Japan. Thank you for your kind attention. 2/2 BIS central bankers' speeches
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 BOJ-IMES conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 24 May2017.
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Haruhiko Kuroda: Monetary policy - lessons learned and challenges ahead Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 BOJ-IMES conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 24 May2017. * * * I. Introduction Good morning. I am honored to welcome such distinguished guests to the 23rd BOJ-IMES Conference. On behalf of the conference organizers, I thank all the guests in this room, in particular those who travelled a long distance to participate in this one-and-a-half-day conference in Tokyo. This year’s conference is titled “Monetary Policy: Lessons Learned and Challenges Ahead.” After my remarks, Mr. Ben Bernanke, former U.S. Fed Chair, will deliver the Mayekawa Lecture based on his experience as an academic researcher and a monetary policy maker. In the afternoon, Professor Mark Gertler, our Honorary Adviser to IMES, will give the keynote speech. Tomorrow, a policy panel session will conclude the program with three panelists, Mr. Charles Evans from the Chicago Fed, Mr. Frank Smets from the European Central Bank, and my colleague at the Bank of Japan, Hiroshi Nakaso. The panel session will be moderated by Professor Marvin Goodfriend, the other Honorary Adviser to IMES. In addition, I am pleased to have three leading economists to present their papers, addressing timely and important issues at the frontier of monetary economics and monetary policy making. I am confident that we will all learn a lot during the conference. II. Three Research Questions at the Top of the Agenda In my opening remarks, I would just like to deliver a sneak peek of this year’s conference by pointing out three major research topics on our agenda. A. Inflation and Its Expectations Dynamics Since the introduction of “Quantitative and Qualitative Monetary Easing (QQE)” in April 2013, raising inflation expectations to anchor them at the price stability target of 2 percent has been a crucial element of the Bank of Japan’s monetary policy management. In September 2016, the Bank published a comprehensive assessment of the policy effects of QQE and other policy measures, including the negative interest rate policy. As companion papers of the comprehensive assessment, the Bank of Japan also published several empirical studies exploring the characteristics of inflation expectations in Japan and comparing them with those in other advanced economies.1 Those studies included an analytical framework developed by Mr. Jeffrey Fuhrer from the Boston Fed, one of today’s paper presenters, to assess inflation dynamics with a special focus on the role of survey-based expectations.2 I am sure that we have learned a lot about inflation expectations in the past few years, but there still remain many research questions on this issue yet to be addressed. For example, there seems to be a consensus that inflation expectations exhibit a certain degree of inertia or persistence, which is difficult to be explained in a full information rational expectations (FIRE) framework even with the classic assumption of nominal (price) rigidity. However, little consensus has been formed regarding the micro-foundations for such seemingly persistent inflation expectations dynamics. Against this backdrop, recent studies have increasingly focused on information rigidity, and I would like to encourage researchers to move on further along with this research agenda. 1/3 BIS central bankers' speeches B. The Natural Rate of Interest The second item on our research agenda is an old and new topic, that is, the natural rate of interest, or, in slightly more technical parlance, the equilibrium real interest rate. The natural rate of interest has long been discussed in macroeconomics and related time series analyses. If we say “our monetary policy stance remains accommodative,” this means that actual real interest rates are kept at a level below the equilibrium real interest rate. This quite naturally gives rise to the question that how we can know the level of the equilibrium real interest rate. This question is more difficult than it appears. The natural rate of interest would have a clear interpretation in a solid dynamic general equilibrium model. Nevertheless, the determinants of the natural rate of interest vary, depending on how the model is specified. It is well known that, in some specific cases, the natural rate of interest coincides with the potential growth rate of the economy, but this is not always the case. Further, when trying to estimate the natural rate of interest, econometricians face a long list of technical challenges. For example, data on the riskfree interest rate with a fixed maturity are not readily available, since there is no absolutely “riskfree” asset in actual financial markets. Also, consumers’ time preferences are hard to estimate, and, moreover, whose time preference we should estimate still remains an unresolved question. With the difficulties just mentioned in mind, central bankers have long made careful policy decisions using some kinds of estimates of the natural rate of interest. The stakes have become even higher in recent years when central banks try to estimate the natural rate of interest. As seen in the debate on the Secular Stagnation hypothesis proposed by Professor Lawrence Summers of Harvard University, uncertainty regarding the natural rate of interest makes it much more difficult for central banks to steer a clear course in terms of policy decisions.3 While I am not going into the details of his hypothesis, many of us can agree that the natural rate of interest has declined in recent years and because of this decline, combined with the effective lower bound on nominal interest rates, many central banks in advanced economies developed new unconventional monetary policy tools and have embarked on carefully crafted but bold actions. In this regard, I would argue that we still face old challenges. C. Heterogeneous Agent Macroeconomics and Distributional Effects of Monetary Policy The third issue is related to monetary policy and inequality. The order I picked the topics does not necessarily correspond to their importance; it is simply that the first two topics are closely related to the real interest rate, while the third topic deals with a very different issue. As a caveat, I would like to clearly state that monetary policy is by no means a policy tool for distributional purposes. With this proviso in mind, let me borrow a phrase delivered by U.S. Fed Chair Janet Yellen: She said, “it is important for policymakers to understand and monitor the effects of macroeconomic developments on different groups within society,” and I completely agree with her on this point.4 In the aftermath of the global financial crisis, a number of pundits argued that macroeconomics and monetary economics are totally useless. One of the misconceptions of such critics is that they believe that modern macroeconomics relies only on representative agent models and ignores important implications arising from various heterogeneities in the economy, such as debtors and creditors, the financial sector and the non-financial sector, importers and exporters, and more controversially, haves and have-nots. Heterogeneous agent models were developed in the 1990s, and have been extended since then.5 From the viewpoint of policymakers, the true issue is whether to employ heterogeneous agent models, instead of handier representative agent models, to examine the implications of heterogeneity for macroeconomic fluctuations. This is a classic case in which Occam’s razor with regard to the choice of the appropriate model applies. This question remains yet to be explored in full depth. We know that increasing attention is being 2/3 BIS central bankers' speeches paid to the distributional effects of economic and other public policies. I would like to reiterate that, under such circumstances, monetary policy is not a tool that is well suited for dealing with inequality or polarization and that central banks should remain focused on the aggregate implications of their own policy decisions. At the same time, however, this does not mean that central banks are allowed to ignore the distributional effects of monetary policy, especially if the distributional effects have an aggregate impact. With this aim, central banks should be, and in fact are, open to learning about heterogeneous agent macroeconomics. These days, much progress has been made on this front in computational economics. Central banks are keenly following the technical progress and will keep abreast with the pioneers on this front as well. III. The Way Ahead We are now about to start the 23rd BOJ-IMES Conference, which has a history of more than a quarter-century. This year’s conference is organized so that discussions can revolve around the three major topics that I mentioned in these opening remarks. Nearly ten years ago, Professor Maurice Obstfeld, currently Chief Economist of the IMF and then-Honorary Adviser to IMES, in this room identified the BOJ-IMES Conference as “a venue in which abstract monetary theory and practical policy questions can comfortably be discussed in full depth and side by side.” I regard his remark as a great compliment to this conference. I am convinced that this year’s conference will produce further insights into more effective central bank policymaking, in a same manner as previous conferences. Thank you. 1 Bank of Japan, “Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE),” 2016. Nishino, Kousuke, Hiroki Yamamoto, Jun Kitahara, and Takashi Nagahata, “Supplementary Paper Series for the ‘Comprehensive Assessment’ (1): Developments in Inflation Expectations over the Three Years since the Introduction of Quantitative and Qualitative Monetary Easing (QQE),” Bank of Japan Review, No. 2016-E-13, 2016. 2 Fuhrer, Jeffrey, “The Role of Expectations in Inflation Dynamics," International Journal of Central Banking,Vol. 8, No. S1, 2012, pp. 137–165. 3 Summers, Lawrence H., Remarks at the IMF Fourteenth Annual Research Conference in Honor of Stanley Fischer, Washington, DC, 2013. Summers, Lawrence H., “Demand Side Secular Stagnation," American Economic Review, Vol. 105, No. 5, 2015, pp. 60–65. 4 Yellen, Janet L., “Macroeconomic Research After the Crisis,” Speech at the 60th Annual Economic Conference Sponsored by the Federal Reserve Bank of Boston, 2016. 5 Krusell, Per, and Anthony A. Smith, Jr., “Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, Vol. 106, No. 5, 1998, pp. 867–896. 3/3 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, Saga, 25 May 2017.
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Makoto Sakurai: Economic activity, prices, and monetary policy in Japan Speech by Mr Makoto Sakurai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Saga, 25 May 2017. * * * I. Economic Activity at Home and Abroad: Recent Developments and the Outlook A. Overseas Economies Let me start with developments in overseas economies. The decelerating trend in overseas economies that had continued since the global financial crisis has at long last come to a halt, and a recovery is starting. Since the latter half of 2016, trade has been recovering globally, due partly to a rise in IT-related demand for smartphones and data centers as well as progress in inventory adjustments in emerging economies. Prices of crude oil and other commodities have been stable, and this is also helping to underpin economic activity, especially in commodity-exporting economies. Under these circumstances, business sentiment has been improving rapidly in many regions. Going forward, overseas economies are likely to continue to recover for the time being. According to the April 2017 World Economic Outlook (WEO) released by the International Monetary Fund (IMF), global growth is expected to rise from 3.1 percent in 2016 to 3.5 percent in 2017, and 3.6 percent in 2018, picking up pace for the first time in three years. The April 2017 estimate also represents an upward revision from the previous estimate made in January 2017. Let me elaborate on developments by region, starting with advanced economies. The U.S. economy has continued to recover firmly, mainly due to a recovery in household spending, owing to a steady improvement in the employment and income situation. While monetary policy has started to be tightened, it is likely that the federal funds rate will be raised only gradually, so that it is unlikely that monetary tightening will restrain economic activity excessively. As for the economic policies of the new U.S. administration, optimistic expectations have receded somewhat, but the majority view still appears to be that expansionary fiscal policies will be implemented, albeit at a later date than previously expected. In this situation, the U.S. economy is expected to continue to see firm growth for the time being, driven mainly by domestic demand, and lead the recovery of the global economy. The European economy has continued to grow moderately, driven mainly by the household sector. There remains uncertainty associated with political issues, such as negotiations on the United Kingdom’s exit from the European Union (EU) and elections in major countries, as well as uncertainty associated with debt problems including those in the financial sector. While such uncertainty is likely to continue to weigh on the economy, it is highly likely that the European economy will continue to grow moderately as a trend. Let me turn to emerging economies. The Chinese economy has continued to see stable growth and is expected to remain on a stable growth path on the whole. This is due to the flexible fiscal and monetary policy conduct by the authorities, although factors such as adjustments of excess production capacity are likely to exert downward pressure on the economy. Many other emerging Asian economies have recently shown a sharp increase in exports. In commodity-exporting economies such as Russia and Brazil, positive developments, including improvements in the trade balance and in business and consumer confidence indicators, have been observed following the bottoming out of commodity prices. As for the outlook, emerging and commodityexporting economies are expected to grow moderately, supported mainly by the effects of the recovery in advanced economies and of economic stimulus measures gradually taking root. 1/6 BIS central bankers' speeches Needless to say, the outlook is not free from uncertainty. As I mentioned earlier, there is persistent uncertainty over issues such as U.S. economic policies, negotiations on the United Kingdom’s exit from the EU, and elections in major European countries. Given that economic fundamentals have recently been sound, it is relatively unlikely that markets will become excessively risk averse in the near term. In fact, contrary to previous expectations, markets reacted favorably to the outcome of the U.S. presidential election. Over the long term, however, economic activity around the world will inevitably be affected if uncertainty over the issues I mentioned heightens further. I believe that particular attention needs to be paid to the fact that this uncertainty is linked to signs of a growing protectionist mood. Over the past few decades, global economic growth has been driven by the expansion of trade and direct investment, spurred by technological innovation. Today, complex supply chains have been established at the global level. If the protectionist mood gains traction, this will restrain trade and direct investment, making it necessary to rebuild existing supply chains. This could cause significant disruption to the global economy and deprive it of its main growth engine. For the global economy to maintain stable growth over the long term, it is essential to ensure the freedom of trade and direct investment. B. Japan’s Economy Next, I will discuss developments in Japan’s economy. The economy has been turning toward a moderate expansion amid the recovery in overseas economies. The annual real GDP growth rate in fiscal 2016 was 1.3 percent, higher than the potential growth rate, which is estimated to be in the range of 0.5-1.0 percent, and the output gap has clearly climbed into positive territory. Going forward, Japan’s economy is likely to continue its moderate expansion for the time being, on the back of the continuing recovery in overseas economies as well as progress in the implementation of the government’s economic stimulus measures, helped, moreover, by a strengthening of synergy effects between economic stimulus measures and accommodative financial conditions. In the Bank’s April 2017 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of Policy Board members’ forecast of real GDP growth was 1.6 percent for fiscal 2017 and 1.3 percent for fiscal 2018. As the economy is likely to continue growing at a relatively high pace above its potential, the positive output gap is also expected to steadily widen. Let us look at Japan’s growth by expenditure item. Since the latter half of 2016, the growth momentum of exports has become more pronounced in line with the recovery in overseas economies. Exports to emerging economies — which had continued to be relatively sluggish — have recently shown a marked increase, led by exports of electronic parts and capital goods to Asia. Going forward, exports are expected to follow a moderate increasing trend in line with the moderate rise in growth in overseas economies. Corporate profits have been at historically high levels, supported not only by the increase in demand at home and abroad but also by the depreciation of the yen since late 2016. Under these circumstances, business sentiment has steadily improved. In the Bank’s March 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion index for business conditions for all industries and enterprises (the proportion of firms responding that business conditions were “favorable” minus the proportion of those responding that they were “unfavorable”) suggested that business conditions have improved for three consecutive quarters, reaching a level last seen in March 2014 just prior to the consumption tax hike to 8 percent. As for the outlook, corporate profits are projected to follow a steady increasing trend, supported by the rise in demand at home and abroad on the back of the improvement in overseas economies and the effects of economic stimulus measures. Business fixed investment has been on a moderate increasing trend as corporate profits have improved. In the March 2017 Tankan, business investment — based on a definition similar to that employed in the GDP statistics, i.e., including software as well as research and development 2/6 BIS central bankers' speeches investment, but excluding land purchasing expenses, in all industries including the financial industry — increased by 1.3 percent in fiscal 2016, and business fixed investment plans for fiscal 2017 signal an increase of 1.9 percent. This latter figure is well above the average growth rate of planned business fixed investment for the next fiscal year in the March Tankan in previous years; the average rate from fiscal 2004 through 2015 stands at minus 0.9 percent. As corporate profits continue to improve, business fixed investment is expected to continue increasing moderately, supported by the synergy effects between accommodative financial conditions and the government’s economic stimulus measures. Supply and demand conditions in the labor market have tightened further, with the active job openings-to-applicants ratio reaching 1.45, which is close to the peak of 1.46 observed during the asset price bubble in the late 1980s. The unemployment rate is 2.8 percent, which essentially represents full employment. In this situation, wages have been rising, albeit at a moderate pace. In the annual spring labor-management wage negotiations in 2017, many firms are likely to have raised their base pay for the fourth consecutive year. While the rate of increase is more or less the same as in the previous year, wage increases have become more widespread, as shown by the notable wage increases at small firms, which are experiencing particularly acute labor shortages. Given that small firms account for a large share of employment, it is expected that the wage growth for employees as a whole will accelerate. Meanwhile, growth in private consumption had been slow following the consumption tax hike in 2014. However, private consumption has recently been resilient due to the improvement in the employment and income situation as well as the wealth effect resulting from the rise in stock prices. Private consumption is expected to gradually become firmer on the back of continued improvement in the employment and income situation. Turning to the outlook for Japan’s economy, some argue that the tightening of labor market conditions limits the room for growth. Personally, I do not agree with this view. Firms have been addressing immediate labor shortages by, for example, closing unprofitable stores, shortening business hours, and limiting orders for their services. I believe that rather than signaling that firms have given up hopes for growth, these steps represent efforts to use labor more efficiently. Furthermore, some firms have decided to invest in labor-saving machinery and equipment such as self-checkout machines. The fact that tighter labor market conditions are encouraging firms to improve productivity seems to be desirable for economic growth over the long term. From a historical perspective as well, labor shortages are not a significant problem in terms of economic growth. In past episodes, the main factor underlying economic growth was not an increase in the labor force. Rather, past economic growth can be explained mostly by improvements in productivity. Also, a sustainable rise in wages achieved through productivity improvements encourages households to be proactive in spending and this, I believe, will likely lead to a stable rise in prices. In this respect, I see these activities by firms in a positive light also from the viewpoint of monetary policy management. C. Prices The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has recently been about 0 percent. Although prices of petroleum products have turned up, housing rent and public utility charges have continued to make negative contributions to CPI inflation. In addition, the reduction in mobile phone prices and charges has also put downward pressure on prices. Compared with the improvements in the output gap and corporate profits, the recent pace of increase in inflation and wages seems somewhat unsatisfactory. One of the factors behind this situation is that in Japan, where the inflation rate has remained very low for the past few decades, it is difficult for people to imagine prices to rise to some extent every year. Recently, price hikes in some services and other industries have received intense media coverage by 3/6 BIS central bankers' speeches newspapers and television programs. Based on this reaction, I feel that in Japan, price hikes still tend to be rather exceptional, and the country has not yet reached a stage where people accept such hikes as a matter of course. Moreover, concerns regarding, for example, the growth potential of Japan’s economy seem to be strengthening households’ tendency to save their income as well as firms’ cautious wage-setting stance. I will return to this point later. That being said, upward pressure on prices is expected to increase further as the moderate economic expansion continues. Going forward, Japan’s positive output gap is expected to widen further on the back of (1) an improvement in capital utilization rates brought about by the increase in exports and production, and (2) a tightening of labor market conditions due to the effects of various economic stimulus measures taking hold. If the observed inflation rate — as a result of the past rise in energy prices and the depreciation of the yen — rises, people’s inflation expectations are likely to change gradually through the adaptive formation mechanism. The Bank’s pursuit of monetary easing through its strong commitment to achieving the price stability target is also expected to contribute to a rise in people’s inflation expectations. Under these circumstances, prices are likely to gradually turn to a clear uptrend. In terms of the median of Policy Board members’ forecasts in the April 2017 Outlook Report, the rate of increase in the CPI for all items less fresh food is projected to steadily accelerate to 1.4 percent for fiscal 2017 and 1.7 percent for fiscal 2018. I feel comfortable with this outlook and believe that the momentum toward achieving the price stability target of 2 percent is intact. II. Monetary Policy In September 2016, the Bank introduced Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control as a new framework for strengthening monetary easing. The framework consists of the two components of an inflation-overshooting commitment and yield curve control. Under the inflation-overshooting commitment, the Bank commits itself to continuing to expand the monetary base until the observed year-on-year rate of increase in the CPI for all items less fresh food exceeds the price stability target of 2 percent and stays above the target in a stable manner. Let me note that the effects of monetary policy spread through the economy with a certain time lag. Therefore, central banks in general conduct monetary policy in a forward-looking manner based on projections for economic and price developments. In this respect, the inflationovershooting commitment is an extremely strong commitment in that it is linked to observed CPI inflation. As I mentioned earlier, in Japan, the expectation — shaped by past experience — that prices will not rise much in the future is deeply entrenched. In this situation, I believe that a strong commitment like this is necessary in order to try to enhance public confidence that the price stability target will be achieved and thereby raise inflation expectations. Under yield curve control, the Bank facilitates the formation of short- and long-term interest rates that are considered most appropriate in light of the 2 percent price stability target. In the current guideline for market operations, the target level for the short-term policy interest rate is set to minus 0.1 percent and the target level for yields on 10-year Japanese government bonds (JGBs) is set to around 0 percent. As part of the interest rate control, the Bank also formulates the guideline of the approximate amount of JGBs to be purchased; currently, the guideline sets out an annual pace of increase in the amount outstanding of the Bank’s JGB holdings of about 80 trillion yen. Interest rate control and JGB purchases are two sides of the same coin. However, while the target for JGB purchases is set as an approximate amount, the interest rate target is a clear-cut commitment. This may lead to the conclusion that the focus is on the control of interest rates. Nevertheless, there is no change in the Bank’s stance of continuing with monetary easing from both a quantitative and an interest rate perspective. In my view, the introduction of yield curve control has made it possible for the Bank to implement monetary easing measures more flexibly, taking account, for example, of the effects on financial intermediation, and the sustainability of these measures has been enhanced. I should also note 4/6 BIS central bankers' speeches that, as a secondary effect, it has become easier to understand the effects of the Bank’s policies. The policy measures implemented prior to QQE with Yield Curve Control — which had set the monetary base as the operating target for monetary policy — also had the effect of lowering interest rates, but people, other than market participants, were probably less familiar with these policy measures. Yield curve control, which directly sets a target level for 10-year JGB yields, more clearly demonstrates accommodative financial conditions to a wider range of economic entities. Let me highlight that even though long-term interest rates have been rising around the globe since the U.S. presidential election, 10-year JGB yields — which the Bank’s yield curve control focuses on — have been firmly kept at the target level. I believe that this has provided an effective demonstration of the positive impact of Japan’s monetary policy. Until now, many central banks have set short-term interest rates as the operating target for monetary policy. Controlling long-term interest rates is a new challenge, and the introduction of this policy framework has involved a certain degree of uncertainty. However, since the introduction of the framework, the Bank has been able to maintain 10-year JGB yields at the target level without particular problems. Going forward, it is important for the Bank to continue to conduct monetary policy with care while accumulating experience through the fine-tuning of operations based on day-to-day market conditions and through close communication with market participants as well as the general public. Let me emphasize that the Bank will work toward the formation of the yield curve that is deemed appropriate for maintaining the momentum toward achieving the 2 percent price stability target. Given that long-term yields overseas have started to rise, some market participants have argued that the Bank in the near future might start considering to raise the long-term interest rate target level. However, given that the recent pace of increase in prices is still moderate and there is lingering uncertainty regarding overseas economies, the Bank, for the time being, should support economic entities’ initiatives by persistently pursuing monetary easing under the current policy framework. III. Challenges Facing Japan’s Economy Japan’s economy has recently been recovering steadily. On the other hand, rises in prices and wages have been relatively moderate. There are various factors behind this, with one example being the previously mentioned concerns among households and firms regarding the future. It seems that households have tended to save their income due to a lack of confidence that income rises are permanent while firms — in anticipation of a possible deterioration in their earnings environment — remain cautious about raising wages, particularly base pay, due to downward wage rigidity. Factors behind the rise in concerns regarding the future likely include: (1) doubts over Japan’s economic growth potential stemming from the low birth rate and aging population and doubts over the sustainability of the social security system, including pensions, (2) relatively unfavorable working conditions for non-regular employees, and (3) the growing protectionist mood across the globe. Given these factors, what policy actions should be taken? As I already mentioned, the current economic situation is favorable, and the positive output gap is likely to widen steadily for the time being. Under these circumstances, it is unnecessary to implement additional policy measures to forcibly push up short-term demand. Doing so would only increase fluctuations in economic activity and thereby do more harm than good; for example, it could hamper efficient resource allocation. It is important to keep in mind that the Bank’s goal is to achieve the price stability target in a stable manner and in that situation realize sustainable economic growth. Even if forcibly boosting short-term demand might succeed in achieving 2 percent inflation, such inflation would not be sustainable. In my view, if people’s concerns regarding the future are rooted in the longer-term challenges that I cited earlier, the only solution is to make steady efforts to address each of these challenges in 5/6 BIS central bankers' speeches earnest, although resolving them might take time. For example, in order to raise the economic growth potential amid the low birth rate and aging population, it is important to provide policy support for firms’ efforts to improve productivity and accelerate innovation. Of course, initiatives to expand the labor force should also continue, such as creating a work environment favorable to women and the elderly. To enhance confidence in the social security system, it is necessary to work on fiscal consolidation. The government’s initiatives for working-style reforms, which include an improvement in working conditions for non-regular employees, are a very significant policy challenge. I would also like to note that although the importance of free trade is widely recognized in the global community, if the protectionist mood gains traction in the future, it will be necessary to reaffirm the value of free trade and direct investment at international forums. Addressing these long-term challenges takes time and may sometimes be a painful process. That is why it will be more difficult to address these challenges in times of recession. Although the current economic situation is favorable, the economy goes through cycles of expansion and recession. It is obviously impossible to maintain economic growth above potential forever. Therefore, it is important to do the utmost to tackle long-term challenges before the economy enters recession. Such efforts will more firmly ensure long-term economic stability and alleviate concerns regarding the future among households and firms, thereby contributing to a rise in inflation and in wages in the near term. 6/6 BIS central bankers' speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 Spring Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 27 May 2017.
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May 27, 2017 Bank of Japan Theory on Financial Markets and Central Banks Speech at the 2017 Spring Annual Meeting of the Japan Society of Monetary Economics Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is a great honor to be invited to the 2017 Spring Annual Meeting of the Japan Society of Monetary Economics. Today I would like to speak about financial markets. What immediately comes to mind when hearing the term financial markets are stock prices and foreign exchange rates, which are discussed on a daily basis in newspaper articles and news reports, and firms and individual investors are very familiar with the markets. At the same time, however, it can be said that once the discussion touches on the specific structures of transactions and pricing mechanisms, as well as interest rates, securities, and derivatives transactions, topics on financial markets turn out to be increasingly technical and require more expertise. Over the years, I have been involved with financial markets in various positions. At the Ministry of Finance, I had daily contact with the foreign exchange markets as Japan's foreign exchange authority. At the Asian Development Bank (ADB), it raised funds necessary for development finance by issuing bonds in global financial markets. Currently at the Bank of Japan, I am deeply involved with financial markets as the Bank conducts monetary policy with a mission of ensuring price stability. Specifically, the Bank decides the guideline for market operations at Monetary Policy Meetings, which are held eight times a year, taking account of developments in economic activity and prices as well as financial conditions, with a view to achieving price stability. Based on this guideline, the Bank conducts daily market operations, such as purchases of financial assets including Japanese government bonds (JGBs) in the financial market. Apart from that, the Bank is involved in many facets of financial markets, including enhancing market infrastructures, collecting and releasing market-related data, and operating settlement infrastructure. Through those experiences, I have always felt that financial markets are a place where theory and reality interact. For example, the pricing mechanisms of stock prices and foreign exchange rates are relatively suited to theoretical analyses, reflecting the characteristics that a great deal of data are continuously produced in financial markets. In fact, all of you here today and those in academia have brought about developments in theory on financial markets and have facilitated a better understanding of the markets. On the other hand, market prices are determined through the activities of a broad variety of participants such as those with financing needs, fund managers, and policy makers. There are cases where financial markets move in line with theory, but it is not uncommon that they do not. Filling in the divergence between theory and reality might lead to the formation of new theory which enables market participants' behavior to be explained rationally. In this way, financial markets have continued to develop with theory and practice stimulating each other. Today, bearing this point in mind, I will attempt to provide a bridge between theory and practice, in discussing theory on financial markets and touching on the reality of the markets from the perspective of central banks. I. Traditional Theory on Financial Markets I would like to commence by talking about traditional theory on financial markets. Prices in financial markets are determined as a result of a diverse range of participants trading various assets and instruments. Two fundamental theories are widely shared regarding valuation and pricing in financial markets. Intrinsic Values First is that prices are formed in the markets based on the intrinsic economic value of assets and instruments that are traded, so they are theoretically explicable. For asset pricing, the present value of expected future cash flow of financial assets is believed to be a starting point. For example, in the stock markets, it is typically considered that "share prices are determined by the present value of the firms' future profits." Long-term interest rates formed in the bond markets are, in principle, considered to be "averages of expected future short-term rates," and theory has been formed where term premiums are taken into account. It is believed that in the foreign exchange markets, the so-called purchasing power parity, with which "fluctuations in foreign exchange rates in the long term reflect differences in inflation rates at home and abroad," provides a reference value. Nevertheless, actual financial markets are affected by many other factors; therefore, short-term market developments cannot be completely explained based on the theory I have just described, and even taking into account developments during a longer period, the degree of applicability and explanatory power differ. That being said, I think that the significance of the theory based on intrinsic economic values is recognized as being the foundation or the starting point of valuations and analyses of market prices. Furthermore, if divergences between theoretical value and market prices continue over a long period, analyses on the cause of those divergences are thought to have important meaning in both theory and practice. Efficient Markets The second understanding is that prices formed in fair and transparent financial markets do not leave opportunities for arbitrage between instruments and between markets. If a clear arbitrage opportunity is left unexploited, someone is most likely to take advantage of that opportunity to gain profits, thereby bringing about a price correction. Assuming the presence of private economic agents in pursuit of profits, this understanding is quite reasonable. Of course, this understanding is based on the following strong premises: (1) investors behave rationally, and (2) information that would affect prices becomes available instantly and there is no information disparity in the markets. Therefore, it is not difficult to find cases where this understanding is not applicable in reality. However, I feel that this theory is significant in that it provides the basic perspectives for the functioning of financial markets. Supposing that an arbitrage opportunity is apparently present, the theory would be the basis for discussions on issues such as why that occurred, whether the market is just taking time to adapt and adjust and an autonomous adjustment can be expected, and whether the situation should be artificially corrected by implementing some sort of measures. II. Mutual Feedback with the Actual Markets The significance of traditional theory on financial markets is generally accepted not only in academia, but also among many market participants. However, as I have mentioned, there are quite a few phenomena in actual financial markets for which such theory might not provide a satisfactory explanation. It is believed these difficulties are attributable to various factors; three of which I will explain now. Difficulties in Utilization of Market Data Practical hurdles are one of the factors that make it difficult for traditional theory to be fully adopted. In relation to asset prices, there often are constraints in utilizing data in practice. Specifically, expected inflation rates and term premiums included in long-term interest rates are not directly observable, even though they are widely accepted concepts. Estimated figures should be seen with a considerable margin as there is no consensus on modeling and formulation. In addition, there are cases where data availability is a high hurdle in practice. Apart from data that are not observable, which I have just described, there are those that are not collected, those that are regarded as private information and are not for general use, and those that are hidden and therefore their usefulness is not known. On this point, it should be noted that, against the background of the evolution of information processing technology such as natural language processing, image recognition, and machine learning, as well as improvements in the performance of computers, a trend towards utilizing types of information that was not expected and vast data for investment decisions and market analyses has started to become widespread.1 It is expected that in the future more information will become available for utilization and will facilitate enhancements in market efficiency, accompanied by initiatives for ensuing privacy and information security. Anomalies in the Markets It has been well known that, as long as it can be assumed there are efficient markets that do not leave arbitrage opportunities unexploited and there are rational investors, phenomena referred to as anomalies that are not rationally explainable can be observed in financial markets. Some of them are market development matters: the calendar effect that finds regularity in market developments according to the specific month or the day of the week, and the small-firm effect that indicates a tendency of difference in expected returns by market value. There are also other anomalies that are to a certain extent understandable as Haruhiko Kuroda (2017), "AI and the Frontiers of Finance," Remarks at the Conference on AI and Financial Services/Financial Markets, Bank of Japan. investor psychology, such as "investors' expectations tend to be biased by their past experiences" and "investors' risk appetite could vary significantly depending on their performances up to that point." There are some fields where instead of being simply regarded as irrational phenomena, an interdisciplinary approach using, for example, psychology, has led to the creation of new theory, such as behavioral economics. Changes in Market Structure Apart from daily price movements in the markets, how to identify structural changes including market infrastructures and to incorporate them into analyses has long been an issue. On this point, from the perspective of a practitioner, I feel that there are fields in which, even with an evident structural change, it is difficult to receive support from a systematic theoretical approach, in part due to the high level of expertise required to correctly recognize the relevant facts. For example, as trading through electronic platforms has become mainstream, along with the significant decrease in trading through human brokers such as floor and telephone trading, the time required for the execution of each market transaction has shortened dramatically. Under these circumstances, the execution of transactions based on algorithms has become widespread and the weight of high-frequency trading has been increasing in some markets. On the other hand, some institutional investors such as sovereign wealth funds and pension funds, in addition to traditional financial intermediaries and investment trusts, have increased their presence as market participants; as a result, there is a possibility that investment styles have become diversified and the time span for returns has lengthened. Although there is no question that these structural changes are exerting some sort of effects on pricing mechanisms in the markets, it is not easy to gain a quantitative grasp of the degree of those effects, even if it is possible to give a qualitative explanation. Furthermore, even if the existence of those effects is recognized, there are often diverging views on the degree of their significance including regarding assessments of their sustainability. Be that as it may, such a viewpoint on changes in market structure often serves as important clues for analyzing phenomena that are difficult to explain, such as when prices follow unusual patterns. Moreover, from the perspective of policy makers, it is considered highly important to foster a better understanding of changes in market structure not only for market analyses in normal times, but also for assessing the situation in times of crises and considering countermeasures. III. Recent Characteristic Events I have described three factors behind the clear division between theory on financial markets and reality. Next, I will give two examples related to that gap between theory and reality. Flash Events First are so-called flash events, or sharp fluctuations in prices in major markets that occurred in a short period of time in recent years. A few of the widely known flash events that have been observed are the flash events in the U.S. stock markets in May 2010,2 the U.S. Treasury market in October 2014,3 and the British pound sterling foreign exchange market in October 2016.4 These cases share the characteristics where prices or yields plunged and then recovered relatively rapidly in a very short period of time. All of those cases attracted significant interest, mainly as they occurred in major markets that are thought to have considerable liquidity. Although the full breadth of the events with regard to what actually took place has not been uncovered, analyses by staff of related authorities and other organizations suggest that a confluence of factors is likely to explain the events, rather than any single cause. Specifically, it has been pointed out that the reduced presence of traditional financial intermediaries that engage in market making and the increase in machine trading such as algorithmic trading and high-frequency trading could have exacerbated those sharp fluctuations in the markets. Fortunately, those flash events did not cause a broad impact on global financial markets, which would have led to disruptions in funding by firms and governments and in asset management by investors. However, if similar phenomena occur frequently in major markets, we cannot completely deny the possibility that they would adversely affect U.S. Commodity Futures Trading Commission and U.S. Securities and Exchange Commission (2010), "Findings regarding the Market Events of May 6, 2010." U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission (2015), "The U.S. Treasury Market on October 15, 2014." Bank for International Settlements (2017), "The sterling 'flash event' of 7 October 2016." financial systems and real economies. Existing theory does not seem to provide a sufficient explanation of how flash events occur; therefore additional research based on broader viewpoints, including on detailed market structures and behavioral patterns of market participants, and theoretical research are awaited. Effects of Financial Regulations The second example is the effects of global financial regulatory reforms following the financial crisis. It is necessary to strengthen financial regulations to restrain excess risk taking by financial institutions and investors and the accumulation of financial imbalances, both of which were causes of the financial crisis. However, there is a possibility that, depending on the content of the regulations and the implementation processes, market making and various arbitrage activity by financial institutions would be affected more than expected. Recently, the introduction of regulatory reform aiming to enhance the soundness of U.S. money market funds (MMFs) brought about a large-scale shift of funds to funds that limit their investments to sovereign assets such as government debts. As a result, it was pointed out that the supply of U.S. dollars to overseas financial institutions -- in which MMFs previously played an active role -- has been constrained, thereby exerting effects on U.S. dollar funding costs. Since the total volume of funds before and after the regulatory reform has not changed, it is possible to claim that such costs will return to their previous levels at some point, as long as arbitrage functions and U.S. dollars can be supplied through other channels. Indeed, some new suppliers of U.S. dollars have started to emerge. However, it seems that it would take a considerable amount of time for both market participants supplying and funding U.S. dollars to adapt to the new environment and change their behavior. Similarly, in the U.S. money markets, it has been reported that, in view of stronger balance sheet constraints stemming from regulations on leverage ratios and other factors, U.S. banks have become less active in interest rate arbitrage. In this situation, the interest rate on reserves at the Federal Reserve -- which was expected to function as the floor on the federal funds rate upon its introduction -- has changed in nature and now virtually functions as the ceiling rate, reflecting the money market structures in the United States. Taking into account the actual role of the interest rate on reserves, the Federal Reserve has proceeded with the normalization of monetary policy by providing a new means of absorbing funds, namely reverse repos, which forms a floor on the federal funds rate. Here, new practices have been created to raise interest rates with abundant liquidity in the financial system. This is an example where regulatory and structural factors exerted significant influence on the interest rate formation mechanism in the market and on central bank market operations. IV. Relationship between Central Banks and the Markets A. Maintaining and Improving Market Functioning Mutual feedback between theory on financial markets and reality -- which I have elaborated on -- holds an important meaning for central banks. With regard to the more practical aspects of business at central banks, monetary policy produces effects as central banks conduct operations through which they influence prices in financial markets, and as this spreads across the markets through arbitrage. Therefore, maintaining and improving market functioning is a very important issue for central banks. In relation to this point, since September 2016, the Bank has implemented yield curve control, in which it sets the short-term policy interest rate at minus 0.1 percent, and purchases JGBs so that 10-year JGB yields remain at around 0 percent. Under this framework, it can be described that market mechanisms allow the entire yield curve to be consistent with the levels of short- and long-term interest rates indicated as the operating targets in the guideline for market operations. Furthermore, the Bank's Securities Lending Facility -- through which it temporarily provides Japanese government securities (JGSs) it holds depending on market conditions -- is conducted from the perspective of supporting that mechanism in the JGS markets. Aiming to ensure stability and high functionality in financial markets, the Bank has actively supported initiatives such as (1) the development of market conventions including in the money markets and foreign exchange markets, (2) shortening of the JGB settlement cycle, and (3) the development of a market level business continuity plan. Moreover, the Bank is committed to enhancing market infrastructures in a broader sense; for example, it has increased the availability of valuable data through collecting market transaction rates and releasing them. Although I will not go into the details today, the Bank administers a robust and convenient settlement system and ensures its stable operation with the same objectives. The Bank will continue to make those steady efforts towards maintaining and improving market functioning. B. Unconventional Monetary Policy and Financial Markets The main mechanism of monetary policy conducted by central banks has traditionally been to influence short-term interest rates through their operations including purchases and sales of short-term government bonds, thereby exerting effects on long-term interest rates and prices of other financial assets. Nevertheless, following the global financial crisis, central banks faced with the "zero lower bound" on nominal short-term interest rates implemented policies directly influencing long-term interest rates and various risk premiums under which they conducted purchases of long-term government bonds and riskier assets such as CPs and corporate bonds, in order to respond to the significant deterioration of their economies. This is referred to as "unconventional monetary policy." As a result, the presence of central banks in the markets has become much more significant and their involvement with financial markets has changed. That "unconventional monetary policy" has been highly effective in ensuring financial market stability and supporting economic activity. At the same time, however, it has given rise to a new issue in analyses of "market prices" formed by incorporating the actions and expectations of various economic bodies, that is, interactions with "the effects of central banks' policies." Further research on this issue is necessary. Moreover, there is a possibility that developments in financial markets would have effects on the sentiment of consumers and businesses as well as on their spending activity, thereby amplifying fluctuations in the real economy. Thus, it is important for macro policy makers to gain an appropriate grasp of the interactions between financial markets and the real economy. C. Market Intelligence In this manner, central banks conduct analyses of information produced in financial markets that are the basis for their policy making and market operations. However, it is not at all easy to understand the causes and background of complex developments in the markets. To this end, it is necessary to carry out multidimensional analyses by, for example, utilizing traditional theories on the intrinsic value of financial assets and the markets' efficiency, as well as findings obtained from new research such as that on pricing mechanisms in the markets under "unconventional monetary policy," and taking into account the views of market participants that actually trade. Furthermore, it is considered necessary to continuously deepen our understanding of market structures such as in terms of systems and regulations, in addition to investors' characteristics and their trading styles, and sharpen our awareness of issues on their potential effects. Such collection of information and analyses on market developments are referred to as "market intelligence." In this process, exchanging opinions with a diverse range of financial market participants is indispensable. It is certainly possible to enhance our understanding of the essence of financial markets by obtaining the views of as many market participants as possible. As a part of those efforts, the Bank's staff are in contact with a broad range of market participants on various levels, and conduct surveys targeting participants in the money markets and bond markets. Concluding Remarks As I have explained, for central banks, financial markets are not only a place to conduct market operations in implementing monetary policy, but also a place to obtain valuable information. In addition, central banks have a significant interest in the sound functioning of the markets, as a condition for the effects of their monetary policies to spread smoothly. In this context, as the Bank has significantly benefited from developments in theory on financial markets, it has made its own efforts in theoretical research, utilizing findings obtained through practices including the conduct of monetary policy, daily market operations, and analyses. From this unique position, the Bank will continue playing a role of serving as a bridge between theory and practice. Today's meeting is a great opportunity for discussions among numerous experts from academia and practitioners from financial markets. I would like to close by expressing my sincere hope that this meeting will generate fruitful discussions, and that further progress in research on financial markets will foster a better understanding of the markets and greatly contribute to the development of the economic society. Thank you for your attention.
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bank of japan
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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, Gifu, 1 June 2017.
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June 1, 2017 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Gifu Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Nagoya Branch. The Bank has implemented quantitative and qualitative monetary easing -- or QQE for short -- since April 2013 and introduced various additional measures such as the negative interest rate policy and yield curve control, all with the aim of achieving the inflation target of 2 percent. As a result of these measures, Japan's economy has been improving. According to the Reference Dates of the Business Cycle released by the Cabinet Office, the economy has continued to improve for 55 months, from November 2012 -- when the economy was at the bottom of the business cycle -- until this June. In addition, in April 2017, the Bank revised its economic assessment upward, stating that the economy "has been turning toward a moderate expansion." I know that some argue that although the economy is said to be improving, they are not feeling the effects of this improvement; however, the improvement is clear even when looking at the employment situation. Today, I would like to explain monetary policy measures conducted by the Bank and what they have achieved, and then discuss what to make of arguments circulating with respect to the purported dangers of bold monetary policy. I. Monetary Easing Measures Table 1 presents an outline of the monetary policy measures conducted by the Bank since the start of 2013. Table 1 Timeline of the Bank's Monetary Policy Measures January 2013 Introduction of the "price stability target" of 2 percent April 2013 Introduction of QQE - Monetary base: increase at an annual pace of about 60 to 70 trillion yen - Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 50 trillion yen October 2014 Expansion of QQE - Monetary base: increase at an annual pace of about 80 trillion yen - Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 80 trillion yen January 2016 Introduction of "QQE with a Negative Interest Rate" - A negative interest rate of minus 0.1 percent is applied to the Policy-Rate Balances in current accounts held by financial institutions at the Bank July 2016 "Enhancement of Monetary Easing" - Amount outstanding of the Bank's ETF holdings: increase at an annual pace of about 6 trillion yen September 2016 Introduction of "QQE with Yield Curve Control" - Yield curve control Short-term policy interest rate: a negative rate of minus 0.1 percent is applied to the Policy-Rate Balances in current accounts held by financial institutions at the Bank Long-term interest rate: the Bank will purchase JGBs so that 10-year JGB yields will remain at around zero percent; with regard to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace -- an annual pace of increase in the amount outstanding of its JGB holdings of about 80 trillion yen - Inflation-overshooting commitment I would like to look at developments in monetary indicators as a result of these measures by looking at two graphs. As can be seen in Chart 1, the monetary base, which is the money that the Bank can control directly, and the balances in current accounts held by financial Chart 1 Rapid Increase in the Monetary Base and Increase in M2 and Bank Lending Introduction of QQE (April 2013) tril. yen Before QQE After QQE M2 +2.8% (annualized) +3.7% Bank lending -0.3% (annualized) +2.5% CY Monetary base Current account balances at the Bank of Japan Bank lending Money stock (M2) Source: Bank of Japan. institutions at the Bank have increased rapidly since April 2013. In line with this, the money stock and lending have been growing.1 Comparing the annual rates of change in the money stock and lending in the four years before and after the introduction of QQE in April 2013 (specifically, comparing March 2009-March 2013 and April 2013-April 2017) shows that these were plus 2.8 percent and minus 0.3 percent respectively before QQE and plus 3.7 percent and plus 2.5 percent respectively after the introduction of QQE. Shioji has shown that QQE did have a quantitative effect -- albeit a small one -- on the rate of increase in the money stock and lending. See: Shioji Etsuro, "Zero kinrika ni okeru nihon no shin'you souzou," [Japan's credit creation under zero interest rates], chap. 2 in Gendai keizaigaku no chōryū 2016 [Currents in modern economics 2016], ed. Teruyama Hiroshi et al., (Tokyo: Toyo Keizai Inc., 2016). Moreover, as shown in Chart 2, due to the decline in nominal interest rates and the rise in inflation expectations, real interest rates -- nominal interest rates minus expected inflation rates -- have greatly declined. Chart 2 Marked Decline in Nominal and Real Interest Rates Introduction of QQE (April 2013) % Nominal interest rate (10-year JGBs) (a) Inflation expectations of economists (b) Inflation expectations of market participants (c) Real interest rate (a-b) Real interest rate (a-c) -1 CY -2 Note: Figures for inflation expectations of economists are the average of expectations for six to ten years ahead, taken from the Consensus Forecasts. Figures for inflation expectations of market participants are expectations for the next ten years, taken from the QUICK Monthly Market Survey (Bonds). Sources: Consensus Economics Inc., "Consensus Forecasts"; QUICK, "QUICK Monthly Market Survey (Bonds)"; Bloomberg. The decline in real interest rates has stimulated investment, boosted stock prices in Japan, and led to a depreciation of the yen. Rising stock prices further raise investment and lead households to increase their consumption expenditure. In other words, economic activity has started to improve through these channels. However, unfortunately, there are some who argue that these kinds of monetary policy measures are dangerous. That is, they argue that regardless of how much monetary easing is conducted, nothing will happen for a while, but at some point, such easing will suddenly give rise to hyperinflation, a surge in interest rates, a collapse of the yen, and so forth. Moreover, the argument goes, low interest rates depress banks' operations, actually impeding banks' financial intermediation function, thus obstructing the effects of monetary easing; or, banks, faced with squeezed profits, will take excessive risk, threatening the stability of the financial system. However, essentially, whatever one does, there are always risks. The reason for doing something even if there are risks is that it produces some sort of result. And looking at the Bank's monetary policy, it certainly has produced results. Therefore, before considering the purported risks in more detail, let us first have a look at the achievements of monetary easing. II. The Achievements of Bold Monetary Easing Chart 3 shows developments in employment and the unemployment rate. Although it has been widely said that the only employment that has been growing is non-regular employment, the share of part-time employees in the total number of employees actually peaked in 2017.2 Moreover, the unemployment rate has fallen substantially. The chart shows that the unemployment rate at the end of the 1990s stood at 5 percent, while Japan's structural unemployment rate in the 2000s was said to be around 3.5 percent. 3 Some had argued that a structural unemployment rate of 3.5 percent implies that monetary policy measures that would reduce unemployment below this level would stir inflation and give rise to a speculative bubble and should therefore be avoided.4 However, the unemployment rate currently stands at 2.8 percent, and there is no inflation or a bubble. Thus, if we understand the argument that Japan's structural unemployment rate is around 3.5 percent as implying that a drop in unemployment below this rate would give rise to inflation, this was incorrect.5 According to the Labour Force Survey by the Ministry of Internal Affairs and Communications, the share of non-regular employees peaked in 2014. The following publications suggested that the structural unemployment rate was in the range of about 3.0-3.5 percent using unemployment-vacancy analysis: (1) Analysis of the Labour Economy 2015 by the Ministry of Health, Labour and Welfare; (2) Annual Report on the Japanese Economy and Public Finance 2015 (Summary) by the Cabinet Office; and (3) Outlook for Economic Activity and Prices by the Bank of Japan. Shirai has argued that "Japan is not suffering from a shortage of demand. Looking at the unemployment rate and the capital utilization rate, there is almost no slack" (translated by the Bank of Japan). See Noguchi Asahi and Shirai Sayuri, "Herikoptā manē no shōtai: Gekitotsu taidan" [The true meaning of helicopter money: A heated debate], Shūkan Ekonomisuto, August 2, 2016. For instance, Hayakawa argues that "although the rate of wage increases is still low, it has started to gradually rise since the unemployment rate reached 3.5 percent. This suggests that the relationship that the structural employment rate ≒ the natural unemployment rate ≒ 3.5 percent generally Chart 3 Improvement in Labor Market Conditions Introduction of QQE (April 2013) million Number of regular employees Before QQE Number of full-time employees Regular employees Number of part-time employees +0.6% (annualized) Unemployment rate (right scale) Youth unemployment rate (age 15-24 years, right scale) Full-time employees -0.1% (annualized) % After QQE +1.9% +1.4% Part-time employees +2.3% (annualized) +3.1% CY Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 4 Improvements in the Fiscal Balance and Government Debt QQE began in April 2013, but these developments indicate that if it had started earlier, the unemployment rate in Japan without doubt would have remained at 3 percent or below throughout. Given that the unemployment rate from the mid-1990s to 2012 on average was roughly 4.5 percent, unemployment was almost 2 percent higher than it could have been. This implies that, because 2 percent lower of workers could not find a job, the GDP level was on average slightly less than 2 percent lower than it would have been. In fact, the loss in GDP may have been even greater than that. What I mean is that an increase in the unemployment rate by 1 percent may reduce GDP by more than 1 percent. The reason is that if there is a recession and output decreases, firms do not decrease employment in line with the decrease in output but instead try to maintain employment levels. In addition, when holds" (translated by the Bank of Japan). See Hayakawa Hideo, "Kinyū seisaku no 'gokai': 'Sōdai na jikken' no seika to genkai." [The 'misunderstandings' of monetary policy: Achievements and limitations of the 'great experiment'] (Tokyo: Keio University Press, 2016). there is a recession, the desire to work decreases, the number of people seeking employment declines, the number of unemployed people falls, and the unemployment rate does not increase to the extent that employment has decreased.6 Moreover, the deterioration in the employment situation during the period before QQE began may have caused the subsequent long-term stagnation. As shown in Chart 3, the rise in the unemployment rate was particularly pronounced among the young. If new graduates cannot get a good job, they will not receive sufficient vocational training and their human capital will decline, which will eventually lead to lower GDP growth rates.7 Given this, it may be possible to correct past mistakes through accommodative monetary policy. If the labor market tightens, those who were previously unable to find a job will be able to find one, while those who involuntarily took up employment as non-regular employees can find regular employment; as a result, they will receive sufficient job training and have more job opportunities, labor quality will rise, and productivity will grow. In other words, it is possible that through a prolonged situation of labor market tightness, the labor force participation rate will rise, there will be active human capital accumulation, productivity will grow, and the real GDP growth rate will accelerate.8 A particular problem in Japan's case is the issue of young people who were looking for a job during the so-called "employment ice age." While there is no clear, generally accepted definition of the "employment ice age" period, some have defined it as the period from the mid-1990s to the mid-2000s, whereas others also include a few years after the global The coefficient regarding how much the real GDP growth rate changes if the unemployment rate changes by 1 percent is called Okun's coefficient, which in Japan is about 3. See Harada Yutaka, Nihon wo sukutta rifure-ha keizaigaku [Reflationism: The economics that saved Japan] (Tokyo: Nikkei Publishing Inc., 2014), 117-118. Nakano Akihiro and Kato Ryo, "'Chōki teitai' ron wo meguru saikin no giron: 'Rireki kōka' wo chūshin ni" [The recent debate on "long-term stagnation": Focusing on the "hysteresis effect"], Bank of Japan Review, no. 2017-J-2, March 2017, http://www.boj.or.jp/research/wps_rev/rev_2017/data /rev17j02.pdf. Janet L. Yellen, "Macroeconomic Research After the Crisis," (speech, "The Elusive 'Great' Recovery: Causes and Implications for Future Business Cycle Dynamics" 60th annual economic conference sponsored by the Federal Reserve Bank of Boston, Boston, MA, October 14, 2016). financial crisis.9 This was a period of recession in which it was very difficult for new graduates to find employment. Many could not find regular employment and instead, out of necessity, became non-regular workers, taking on part-time jobs or temporary work. If these people were to become regular employees, wages, productivity, and tax revenues including social insurance contributions would rise. This is desirable not only for them individually, but also for Japan as a whole. Of course, if we set too much store by the "high-pressure economy" argument -- which suggests that labor market conditions should be kept tight through monetary easing -monetary policy may be tightened too late despite signs of inflation, potentially leading to intolerably high inflation. While I think that the "high-pressure economy" argument is probably correct, in actual monetary policy conduct, we should prioritize the 2 percent inflation target and regard further improvements in employment and increases in the growth rate as desirable to the extent that they can be achieved. Furthermore, the fiscal situation is also improving. Chart 4 shows the fiscal balance of the general government divided by nominal GDP. As can be seen in the chart, the government deficit relative to GDP deteriorated sharply to 8 percent in the wake of the global financial crisis in 2008. It remained at that level for a while, but has improved by 6 percentage points since 2013 and now stands at about 2 percent relative to GDP. Part of the improvement of course is due to the consumption tax hike in 2014, but the tax hike accounts for only 8 trillion yen or 1.5 percentage points of GDP; the remaining 4.5 percentage points are due to the economic growth brought about by economic measures such as QQE.10 Moreover, the amount outstanding of government debt relative to nominal GDP, as shown in the chart, peaked in 2014 and has been declining since. The improvement in the fiscal Genda Yuji et al., Shūshoku hyōgaki sedai no keizai, shakai eno eikyō to taisaku ni kansuru kenkyū iinkai hōkokusho [Report of the study group on the effects of the employment ice-age generation on the economy and society as well as countermeasures] (Tokyo: Japanese Trade Union Confederation Research Institute for Advancement of Living Standards, October, 2016). Ministry of Finance, Nihon no zaisei kankei shiryō [Japan's Fiscal Condition], April 2017, 22. situation to a considerable extent also owes to the improvement in the economic situation due to economic measures including QQE. Chart 4 Improvements in the Fiscal Balance and Government Debt % Introduction of consumption tax (April 1989) Consumption tax hike (April 2014) Consumption tax hike (April 1997) % Introduction of QQE (April 2013) -2 -7 -12 -17 -22 -27 CY -32 Primary balance (SNA) Fiscal balance (Flow of Funds Statistics) Amount of government debt outstanding (right scale) Note: The series show ratios relative to nominal GDP. The fiscal balance is the financial surplus or deficit of the general government in the Flow of Funds Statistics. Figures for the amount of government debt outstanding and the primary balance are converted from annual to quarterly data through linear interpolation. Sources: Cabinet Office; Bank of Japan. As discussed so far, the Bank's bold monetary easing has produced excellent results. III. What Are the Dangers of QQE? Given that QQE has clearly produced results, criticism of the Bank's monetary policy naturally has shifted to the argument that "although nothing has happened so far, there is a danger that a serious problem may arise in the future." I call this kind of argument the "big rock theory." As illustrated in Chart 5, the "big rock theory" holds that there is a big rock on the slope that blocks the way. However, if one tries to move the rock out of the way, it hardly moves at first, but once it does get rolling, it will not stop. The argument therefore maintains that it is better not to try to move the rock out of the way. Turning back to monetary policy, this implies that no matter how much monetary easing is pursued, nothing Chart 5 Big Rock Theory Big rock theory: a big rock on a slope hardly moves at first if one tries to move it out of the way, but once it does get rolling, it will not stop, and therefore it is better not to try to move the rock out of the way. Big rock Slope happens for a while, but suddenly at some point it will give rise to hyperinflation, a surge in interest rates, and a collapse of the yen. For this reason, the theory argues, monetary easing should not be pursued. In my opinion, such fears are groundless.11 The criticism leveled by "big rock theory" proponents seems to have converged on the dangers associated with the exit from monetary easing. I think the reason is that hyperinflation and the collapse of the yen are unlikely to happen and the proponents of the "big rock theory" have realized that their warnings will not convince the public. "Exit" here refers to the Bank's termination of monetary easing followed by an increase in interest rates and a reduction of the monetary base because achieving 2 percent inflation is in sight as a result of monetary easing. Actually, if you think about it, the "big rock theory," which focuses on dangers related to the exit, assumes that, as a result of monetary easing, a situation arises in which prices increase and monetary policy must be tightened. Therefore, the proponents of the theory do not hold the view that nothing will happen no matter how much monetary easing is pursued; rather, they recognize the effectiveness of QQE. From See Harada Yutaka, Kataoka Goushi, and Yoshimatsu Takashi, eds., Abenomikusu wa shinkasuru: Kin'yu ganseki riron wo tou [Abenomics strides ahead: Questioning the financial big rock theory] (Tokyo: Chuokeizai-sha, Inc., 2017). my perspective, this is a welcome argument, since it recognizes the effectiveness of monetary easing. At the exit, the Bank will have to raise interest rates. There are two possible ways to do so: by abandoning the negative interest rate policy currently carried out by the Bank and raising the interest rate applied to excess reserves; or by selling Japanese government bonds (JGBs) held by the Bank. While the Bank at the moment has not decided anything with regard to the exit, what I would like to explain is easier to understand by focusing on an increase in the interest rate applied to excess reserves, so let me do so here. According to proponents of the "big rock theory," the Bank will make large losses when it raises the interest rate on excess reserves because of the low interest rates on JGBs purchased by the Bank in the past. It is of course possible that the Bank may register losses because it will receive low interest rates while paying high interest rates. Proponents of the "big rock theory" argue that if the Bank does indeed make losses, confidence in the currency would be undermined, there would be hyperinflation, the yen would collapse, and interest rates would surge. However, please think about it carefully. Essentially, does anyone use money paying attention to whether the central bank makes a profit or a loss? Moreover, the central bank, in return for purchasing government bonds in the market, supplies currency, that is, the monetary base. While yields even on JGBs at present are around 0 percent, they were 3 percent until around the middle of the 1990s. The reason is that back then the real economic growth rate was high and prices were rising somewhat. If prices rise, interest rates will also rise eventually. This means that it will be possible to purchase higher yielding JGBs. Of course, until that time, the Bank will have to hold low yielding JGBs while paying high yields to banks in order to prevent an overheating of the economy. However, in the end, the central bank will always make a profit in the long run, since it buys high yielding JGBs using cash and current account deposits that carry almost no costs. Thus, the Bank will not make a loss in the long run that could pose a danger.12 Yoshimatsu Takashi, "Chūō ginkō no deguchi no kiken towa nanika" [What are the dangers of a central bank exit?], chap. 9 in Abenomikusu wa shinkasuru: Kin'yu ganseki riron wo tou [Abenomics strides ahead: Questioning the financial big rock theory] ed. Harada Yutaka et al., (Tokyo: Chuokeizai-sha, Inc., 2016). Another criticism that has been leveled against QQE is that it has a negative impact on banks' operations. Both real and nominal interest rates have declined as a result of the bold monetary easing measures. While low interest rates support the long-term economic recovery, some argue that they also undermine the operations of banks, which impedes the effects of monetary easing. Because banks' profits are based on the difference between deposit interest rates and the loan rates they charge and it is difficult for them to impose negative deposit interest rates, it is certainly the case that as loan interest rates approach zero, banks' profit margins necessarily decrease. However, the decline in interest rates is not only due to the Bank's policy measures. To start with, the decline in real interest rates is also due to a decline in the long-term growth potential of Japan's economy as well as structural changes in the supply of and demand for funds. This structural change in the supply of and demand for funds is due to the fact that firms have become excessive savers and do not borrow money. Meanwhile, the decline in nominal interest rates is due to the decline in prices. As prices rise, nominal interest rates will eventually also rise. 13 Therefore, in order to raise interest rates, it is necessary to continue with bold monetary easing and achieve the 2 percent price stability target. Moreover, as the economy improves, the number of people unable to repay loans will decrease, the number of people who want to borrow money will increase, and banks will be able to raise lending rates again. IV. Why Has the Price Stability Target Not Yet Been Achieved? As mentioned earlier, the monetary easing measures have been effective and warnings of the dangers of these measures make little sense. The only thing that the measures have not achieved is an increase in prices. Let me start by looking at developments in prices and then consider why the price stability target of 2 percent has not yet been achieved. On the link between monetary policy, structural changes in the financial environment, and interest rates, see Harada Yutaka, "Naze nihon no kin'ri wa hikuinoka" [Why are Japan's interest rates low?], Keiki to saikuru, no. 62, November 2016. Chart 6 shows the year-on-year rate of change in the consumer price index (CPI) on a quarterly basis. The chart may give the impression that achieving the price stability target of 2 percent is a long way off. However, in order to grasp the underlying trend in consumer prices, it is necessary to look at the rate of change in the CPI excluding fresh food and energy, since the CPI excluding fresh food but including energy is affected by temporary fluctuations in oil prices. The important thing to note when looking at these indexes is that their underlying trend was negative from the mid-1990s onward, but following the introduction of QQE the rate of change in the CPI excluding fresh food and energy turned positive and since then has continued to be on an uptrend.14 Chart 6 Breakdown of the CPI Consumption tax hike (April 2014) Consumption tax hike (April 1997) % Introduction of QQE (April 2013) Contribution of CPI (all items less fresh food and energy) Contribution of CPI (energy) CPI (all items less fresh food) CPI (all items less fresh food and energy) -1 -2 CY -3 Note: The CPI is adjusted for the effects of the changes in the consumption tax by deducting 2.0 percentage points at the time of the introduction of the tax in 1989, 1.5 percentage points at the time of the first hike in 1997, and 2.0 percentage points at the time of the second hike in 2014. Source: Ministry of Internal Affairs and Communications. While the average annual rate of change in the CPI excluding fresh food and energy between April 1999, when it first turned negative, and April 2013 was minus 0.5 percent, it has been plus 0.6 percent between the start of QQE in April 2013 and April 2017 (excluding the 2 percent increase in the CPI as a result of the consumption tax hike). Next, let us have a more detailed look at developments in prices. Immediately after the introduction of QQE in April 2013, the rate of change in the CPI excluding fresh food and energy increased from around minus 0.5 percent to around plus 1 percent. After losing momentum in the wake of the consumption tax hike in April 2014, the rate of change turned upward again with the expansion of QQE, but then started to decline once again in 2016. However, as I will explain later, I believe that the rate of change will likely turn upward once more due to the expected decline in the unemployment rate and other factors. Certainly, the 2 percent price stability target has not yet been achieved. Moreover, many argue that even though the economy is said to have improved, increases in incomes are minimal, and thus they do not feel much improvement. The Bank of course also does not want prices to rise just for the sake of it but because the economy is improving. That is, the Bank conducts monetary policy based on the premise that deflation is detrimental because it leads to economic stagnation and that if we escape from deflation and achieve the 2 percent price stability target, the economy will also improve. So, why has the economy not recovered that much? Let me consider why the 2 percent price stability target has not been achieved. Analyses by the Bank suggest that a major reason for this is the decline in inflation expectations, and that the following two factors have played a major role in the decline in inflation expectations. First, (1) the decline in crude oil prices, (2) the weakness in demand following the consumption tax hike in April 2014, and (3) the slowdown in emerging economies and volatile global financial markets, have lowered the observed inflation rate. And second, amid this decline in the observed inflation rate, inflation expectations -- after having been largely flat -- weakened, reflecting the fact that expectations formation in Japan is largely adaptive, that is, backward-looking.15 Among these factors, let me focus on the consumption tax hike and the sluggishness in the global economy. Bank of Japan, "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. Chart 7 shows developments in real consumption before and after the consumption tax hike. The chart indicates that following the consumption tax hike, consumption, as measured by the consumption activity index compiled by the Bank, has remained weak for more than two years, although it is now finally showing signs of recovery. The consumption tax hike from 5 percent to 8 percent had the effect of raising consumer prices by 2 percent. Thus, if we exclude the increase in consumption due to frontloading and the subsequent decline in response, real consumption should have fallen by 2 percent and then continued along the trend observed before the tax hike. While the chart depicts such a trend, actual growth in consumption has declined considerably and has fallen drastically below this trend particularly since the end of 2015. Moreover, although wages have not grown very much, if we exclude the effects of the consumption tax hike, real employee income -- i.e., wages multiplied by the number of employees -- has consistently grown, since employment has been consistently improving during this period. Thus, even though real income is increasing, the situation continues that consumption is not increasing. Chart 7 Stagnation in Real Consumption CY 2010=100 Introduction of QQE April 2013 Consumption tax hike April 2014 Trend after the introduction of QQE Trend after a downward shift of 2 percent Trend after a downward shift of 3.5 percent CY Consumption activity index World trade volume Real employee income Note: Real employee income is obtained by multiplying nominal wages by the number of employees (Labour Force Survey) and adjusting inflation by the CPI for all items. Sources: Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; CPB Netherlands Bureau for Economic Policy Analysis. Why is consumption not increasing? One potential explanation is that, given that there had been plans to further raise the consumption tax to 10 percent after the hike to 8 percent, people already responded in their consumption behavior as though the tax rate was raised by 5 percentage points to 10 percent.16 In that case, it would be no surprise that real consumption expenditure declined by 3.5 percent. However, even if we draw the trend based on this assumption, consumption has fallen further behind the trend since the end of 2015. Moreover, if the explanation that people already responded to an expected 10 percent consumption tax hike is correct, the next consumption tax hike to 10 percent should have little effect on consumption, which I find hard to believe. In any case, if real consumption decreases, demand will decline and prices will be subject to downward pressure. While it is difficult to know exactly how large this downward pressure is, it is certain that such pressure will exist. Another factor that should be mentioned is trends in the global economy. As shown in Chart 7, it is clear that the stagnation in global trade since 2015 has cooled consumer sentiment through a decline in exports and stock prices, and has delayed the recovery of Japan's economy. However, the tightening of the labor market seen in the decline in the unemployment rate shown in Chart 3 should lead to a rise in wages and eventually in prices. There are already signs of this happening. In this context, it is useful to look at the Phillips curve, which shows the link between the unemployment rate and the inflation rate. Chart 8 shows the Phillips curve for Japan. In the chart, the inflation rate is shown on the vertical axis, the unemployment rate on the horizontal axis, and the Phillips curve is given by the downward-sloping curve. As can be seen, prices only rise gradually as the unemployment rate falls, but once the unemployment rate approaches 2 percent, prices rise quickly. The unemployment rate has already fallen to 2.8 percent. Therefore, there is no doubt that prices will eventually rise as the unemployment rate continues to fall. Unayama Takashi, "Keizai kyoshitsu 2014-nen shouhizouzei no kyōkun" [Economics class: What the 2014 consumption tax hike taught us], Nikkei, May 23, 2016. Chart 8 Phillips Curve and Tightening of the Labor Market y/y % chg. CPI (all items less fresh food and energy) Price stability target of 2 percent -1 -2 -3 Unemployment rate % Source: Ministry of Internal Affairs and Communications. Concluding Remarks As stated so far, the Bank's monetary policy measures have produced excellent results so far and with regard to prices, at least a situation in which there is no longer deflation has been achieved. Finally, I would like to say that the argument that economic growth is inhibited by a shortage of labor is incorrect. The argument essentially states that what impedes economic growth is the shortage of labor brought about by monetary easing measures. The argument therefore implies that monetary easing should not be carried out. 17 However, because monetary easing measures have increased employment, they have boosted economic growth. Moreover, as a result of the shortage of labor, wages will rise. It is highly productive firms For instance, in the Mainichi Shimbun (April 4, 2017, morning edition), referring to the improvement in the diffusion index for employment conditions in the Tankan (Short-Term Economic Survey of Enterprises in Japan), it was stated that labor shortages were becoming more severe, giving rise to concerns that such shortages might impede the recovery. that can pay high wages, while firms with low productivity can only pay low wages. Therefore, if wages increase, highly productive firms will survive, and labor productivity in the economy overall will increase as well. In other words, rising wages due to a shortage of labor will promote productivity growth. On the other hand, some argue that low interest rates impede the economic metabolism. 18 They argue that, as a result of the decline in interest rates, firms' interest burden decreases, firms that should exit the market do not do so, and the productivity of the economy as a whole declines. However, what happens if firms exit and unemployment surges? Productivity per person employed may increase, but output overall will decrease. Although it might be an exaggeration to say that this would result in a surge in unemployment and social instability, it would inevitably lead to problems. On the other hand, firm turnover caused by labor shortages does not cause such problems. I think that there is no one now who would answer yes when asked "Are you a deflationist, thinking that it is better for prices to fall?" In that sense, we are all reflationists now, hoping that prices will rise and the economy will improve.19 That is why the Bank continues to pursue its monetary easing policy. Thank you for your attention. For example, Shirakawa stated that "we may have to take into account the risk that a continuation of low interest rates will affect the productivity of the overall economy and lower the potential growth rate endogenously." See Shirakawa Masaaki, "Central Banking: Before, During, and After the Crisis," (remarks, Conference Sponsored by the Federal Reserve Board and the International Journal of Central Banking, Washington, D.C., March 24, 2012), http://www.boj.or.jp/en /announcements/press/koen_2012/ko120326a.htm/. Harada Yutaka, "Wareware wa mina rifure-ha dearu" [We are all reflationists], Shūkan Ekonomisuto, January 24, 2017.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the University of Oxford, Oxford, 8 June 2017.
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June 8, 2017 Bank of Japan The Role of Expectations in Monetary Policy: Evolution of Theories and the Bank of Japan's Experience Speech at the University of Oxford Haruhiko Kuroda Governor of the Bank of Japan Introduction I am very honored to have the opportunity to give a speech at Oxford University today. At the same time, it is also an extremely emotional experience from a personal point of view. I was a graduate student at Oxford University from 1969 to 1971 and was able to enjoy Oxford, the university, and its colleges in my younger days. I was dispatched here by Japan's Ministry of Finance, planning to study public finance. However, since Lady Ursula Kathleen Hicks, a prominent scholar in public finance, had already retired, I decided to study monetary economics under Professor Richard Good Smethurst. In those days, Emeritus Professor John Richard Hicks provided a series of seminars on monetary economics for graduate students, and I participated in it. The lectures and seminars at Oxford gave me the opportunity to study monetary economics and monetary policy in earnest, but I certainly could not have imagined at the time that about half a century later I would give a speech here about monetary policy as Governor of the Bank of Japan. In my speech today, titled "The Role of Expectations in Monetary Policy: Evolution of Theories and the Bank of Japan's Experience," I would like to talk about the evolution of theoretical ideas about monetary policy and the conduct of monetary policy by the Bank of Japan in recent years. In April 2013, the Bank of Japan introduced quantitative and qualitative monetary easing (QQE), which considerably differs from the policy framework employed until then and which has since been further enhanced and strengthened. These policies conducted by the Bank of Japan, together with policy initiatives by central banks in Europe and the United States in recent years, are frequently classified as unconventional monetary policies. However, the roots of the ideas underlying these policies can be traced back to work by economists in the United Kingdom nearly a century ago. In today's speech, I would like to provide an overview of the debate in economics since the first half of the 20th century, discuss the implications for monetary policy today, and consider remaining issues. I. Intellectual Origins: Monetary Policy Discussions by Economists in the United Kingdom in the First Half of the 20th Century Monetary policy discussions by economists in the United Kingdom in the first half of the 20th century provide extremely useful insights into monetary policy today. I am particularly surprised by the fact that those insights from almost a century ago are relevant to the unconventional monetary policies in advanced economies in recent years. A British economist in the first half of the 20th century that everyone first and foremost thinks of probably is John Maynard Keynes (Chart 1). Keynes, the founder of macroeconomics, highlighted the role of central bank monetary policy in guiding long-term interest rates during a recession through the purchase and sale of long-term government bonds and other measures. As is well known, in 1933, Keynes sent an open letter to U.S. President Roosevelt, urging a reduction of long-term interest rates through purchases of long-term government bonds. At the same time, Keynes, in his seminal book, The General Theory of Employment, Interest, and Money published in 1936, accurately pointed out that when long-term interest rates decline to certain levels, this can give rise to a "liquidity trap" -- a situation in which long-term interest rates do not fall further and the monetary authority loses effective control over interest rates because people expect interest rates to rise in the future and hold cash instead of investing in long-term bonds. What is surprising is that Keynes had predicted the possibility of a liquidity trap long before such a situation had ever arisen. In fact, although a liquidity trap had never actually arisen when the General Theory was written, he stated that "this limiting case might become practically important in future." As you all know, Keynes not only discussed the liquidity trap but also keenly examined many other issues of macroeconomics from an academic standpoint and had a tremendous influence on macroeconomic policies afterward. However, regarding the topic of my speech today -- expectations and monetary policy -- another scholar providing extremely useful insights is Ralph George Hawtrey, a close friend and intellectual sparring partner of Keynes. As a government economist known for numerous publications written while acting as Director of Financial Enquiries at the U.K. Treasury for a few decades, Hawtrey devised his own economic theories rooted in practice and highlighted the role of monetary factors in the business cycle. From an extremely early stage, he identified the importance of conducting monetary policy in a forward-looking manner (Chart 2). In his book Monetary Reconstruction published in 1923, he stated that "it is not the past rise in prices but the future rise that has to be counteracted." He also pointed out that "[t]he problem is a psychological one" and that "a very relevant factor in the psychological problem is the traders' expectations as to the intentions of the authority which fixes rates." In other words, Hawtrey highlighted that private entities decide their actions based on expectations for the future, identifying -at this extremely early stage in the study of economics -- that the central bank's policy stance toward future price stability is an important factor working on the expectations of such economic entities. Hawtrey also provides us with instructive insights about why interest rate control by the central bank produces significant policy effects (Chart 3). In his 1938 book A Century of Bank Rate, he argues that "[t]he pressure applied to traders by a moderate rise in the short-term rate of interest, say, 1 percent, is undeniably very slight. Yet apparently the Bank of England always counted on a rise of 1 percent or even of 0.5 percent having a noticeable effect." He continues by stating that, when the Bank of England raises the official discount rate by 1 percent, "a trader would reason that this was intended to have a restrictive effect on markets, and that, if the effect was not brought about, the rate would simply go higher and higher till it was." Hawtrey thus probably was the first to clearly point out that the reason why a minor change in the policy interest rate creates a major policy effect is people's expectations regarding the future monetary policy stance of the central bank. I vividly remember hearing about this last point from Professor John Richard Hicks during my days at Oxford. However, while Hawtrey called this policy effect resulting from people anticipating the intentions of the central bank the "psychological effect," Hicks argued that the effect was based on extremely rational behavior of economic entities (Chart 4). From a theoretical perspective, Hicks found this to be a stronger argument with regard to the transmission mechanism of monetary policy than Hawtrey's argument. Hicks called this the central bank's "announcement effect," saying that the central bank's policy "should almost immediately result in a shift in expectations," and that "[w]hat I learn from Hawtrey's analysis is that the 'classical' Bank Rate system was strong, or could be strong, in its announcement effects." This identification of the announcement effect by Hicks is based on the so-called expectations theory with regard to long-term interest rates. He therefore can be said to have pointed out at an early stage the importance of what today is called "forward guidance." This brief outline indicates that, nearly a century ago, British economists such as Keynes, Hawtrey, and Hicks had already introduced or anticipated key concepts related to the unconventional monetary policies implemented today, such as the liquidity trap, forward-looking monetary policy, and forward guidance. Although their arguments were largely conceptual, they were later formalized by scholars such as Friedman and Lucas as well as the New Keynesians, and the essence of their arguments lives on in contemporary economics in a refined form. Central bank policy makers like myself have been influenced both directly and indirectly by the contributions of these British economists. Of particular importance is the point that a strong determination by the central bank to stabilize prices will work on people's expectations and increase the effectiveness of monetary policy. This is also the essence of the monetary easing that the Bank of Japan is currently pursuing. Based on these background considerations, I would now like to explain the Bank of Japan's policy conduct in recent years. II. Deflation in Japan: Declines in Potential Growth Rate and Inflation Expectations Since the 1990s, economic volatility has sharply decreased in many advanced economies. Former Federal Reserve Chairman Ben Bernanke referred to this as the "Great Moderation" and argued that a major reason was the dramatic improvement in the ability of central banks in those economies, including the United Kingdom, to stabilize inflation expectations through the introduction of measures such as inflation targeting. Meanwhile, Japan's economy found itself in a completely different situation. Japan experienced a major asset bubble from the late 1980s to the early 1990s and, following the collapse of the asset bubble, suffered a sharp economic slowdown and serious financial instability. Moreover, firms had to deal with the so-called three excesses -excess production capacity, excess employment, and excess debt -- while financial institutions had to grapple with the nonperforming loan problem. While the negative legacy of the asset bubble had been more or less dealt with by the mid-2000s, Japan's potential growth rate, which had been around 4 percent in the early 1990s, dropped to about 1 percent by the late 1990s (Chart 5). On the price front, the annual rate of change in consumer prices fell into negative territory in 1998 and generally remained negative over the following decade and a half. Against this background, inflation expectations also seem to have declined, although they were not accurately captured in a timely manner. On the monetary policy side, the policy interest rate, which was 6 percent in the early 1990s, had been lowered to 0.5 percent by 1995. At this point, conventional monetary easing measures through cuts in the short-term policy interest rate had been more or less exhausted. Paul Krugman dubbed this situation "Japan's trap" and stated that Japan had actually fallen into a liquidity trap, which had long been regarded as just a theoretical possibility written in the back pages of macroeconomic textbooks. In order to get out of this trap, the Bank of Japan introduced a zero interest rate policy in 1999, followed, in 2001, by quantitative easing, in which the outstanding balance of current accounts that financial institutions hold at the Bank of Japan was set as the operating target for money market operations. Thus, the Bank of Japan pioneered the introduction of unconventional monetary policies, but unfortunately Japan was unable to overcome deflation. Why did Japan's economy fail to get out of the liquidity trap even though the Bank of Japan had taken unprecedented monetary policy steps? With the benefit of hindsight, we now know that Japan faced a simultaneous decline in the natural rate of interest and in inflation expectations. Under these circumstances, as nominal short-term interest rates faced the zero lower bound, it was difficult to lower real interest rates to levels well below the natural rate of interest and achieve sufficient monetary easing. As a result, the downturn in growth during this period caused a decline in prices, further reducing growth through the rise in real interest rates, so that weak economic growth and deflation reinforced each other over a long period. Then, in 2008, the global financial crisis led to another sharp contraction in Japan's economy (Chart 6). Even though Japan's financial institutions had already resolved the nonperforming loan problem by that time and had only limited exposure to subprime-related products, Japan experienced a precipitous decline in real GDP that was more severe than that in Europe and the United States, which was the epicenter of the crisis. There are a number of reasons for this, but what certainly played a role is that at the time the policy interest rate in Japan was only 0.5 percent, so that -- unlike in Europe and the United States, where rate cuts of 3-4 percentage points were possible -- there was little room for a monetary policy response through cuts in the short-term policy interest rate. This episode highlights the importance of bringing about an increase in the so-called neutral interest rate -- that is, the nominal interest rate level that is neutral to economic activity -- by anchoring inflation expectations at about 2 percent and of securing the ability of monetary policy to respond. III. QQE: Monetary Policy to Work on Expectations I took office as Governor of the Bank of Japan in March 2013 and immediately introduced a monetary policy regime -- quantitative and qualitative monetary easing (QQE) -- that is quite different from past regimes. QQE consists of two pillars: directly working on people's expectations through a price stability target of 2 percent and a strong and clear commitment to doing whatever it takes to achieve this, and (2) directly encouraging a decline in long-term interest rates through large-scale purchases of long-term Japanese government bonds (JGBs). If inflation expectations rise as a result of the former and nominal long-term interest rates fall as a result of the latter, this will push real interest rates to levels below the natural rate of interest even in the face of the zero lower bound. In additional steps, the Bank of Japan in January 2016 introduced a negative interest rate policy in order to address the strong headwinds caused by turbulence in global financial markets. The negative interest rate policy aims at exerting further downward pressure on interest rates across the entire yield curve by pushing down the short end of the yield curve, in combination with large-scale purchases of JGBs. Thereafter, in September 2016, the Bank conducted a comprehensive assessment on developments in economic activity and prices as well as policy effects since the introduction of QQE; based on the findings, the Bank introduced yield curve control, which focuses on long-term interest rates in addition to short-term interest rates as the operating target. However, the basic approach of lowering nominal interest rates across the entire yield curve and lowering real interest rates by raising inflation expectations has remained unchanged. In modern central banking, QQE is classified as unconventional monetary policy, but from a somewhat longer-term perspective, it can be said to be a contemporary application of Hawtrey's theory on the importance of guiding expectations and Keynes' theory that monetary easing can be conducted through the purchase of long-term government bonds. An old East Asian proverb -- "visiting old, learn new" -- says that one can derive new understanding from learning the lessons of the past, and I think this is particularly apt with regard to the intellectual journey leading up to QQE. In practice, QQE has produced its intended effects. Inflation expectations climbed notably after the introduction of QQE. This demonstrates that a strong determination by the central bank pushes up people's forward-looking inflation expectations. In addition, the large-scale purchases of JGBs as part of QQE have exerted downward pressure on nominal interest rates across the entire yield curve. As a result, the Bank of Japan has succeeded in reducing real interest rates to levels well below the natural rate of interest for the first time in its two-decade long battle with the zero lower bound on the short-term policy interest rate (Chart 7). These monetary easing effects have stimulated economic activity both in the corporate and household sectors, and the output gap has improved substantially. Corporate profits are at record highs. The unemployment rate has fallen to less than 3 percent, meaning that Japan has almost achieved full employment (Chart 8). Wages are rising moderately with the tightening of labor market conditions. An especially noteworthy change is that the practice of regular increases in base pay, which had disappeared during the prolonged deflation since the second half of the 1990s, has returned and has now been observed for the fourth consecutive year. A virtuous cycle between rising inflation and wage increases has been operating. In other words, Japan is no longer experiencing deflation in the sense of a sustained decline in prices. IV. New Challenges under Low Inflation It can be said that Japan's experience over the past four years illustrates the effectiveness of the kind of monetary policy approach that works on expectations first pointed out by economists in the first half of the 20th century. That being said, while the policy approach has steered Japan's economy in the right direction, our intellectual journey has not yet been completed. The rate of change in the consumer price index (CPI) recently has been around 0 percent and there is still a long way to go until the price stability target of 2 percent is achieved. The main reason is that inflation expectations, which had clearly risen as a result of the introduction of QQE, have since declined again and have continued to be subdued (Chart 9). Analysis by the Bank of Japan suggests that, as a result of prolonged deflation, the backward-looking, or adaptive, component in the formation of inflation expectations continues to be much stronger in Japan than in Europe and the United States. Therefore, if, for whatever reason, the observed inflation rate declines -- even if only temporarily -- this will tend to drag down inflation expectations. With the observed inflation rate having fallen due to a drop in crude oil prices since autumn 2014 by more than 70 percent and to turbulence in global financial markets in 2015 and 2016 reflecting uncertainty regarding the prospects of emerging economies, this meant that inflation expectations also declined. The Bank of Japan aims to fundamentally dispel the deflationary mindset that has become entrenched among the public, but changing people's inflation perceptions is not easy. As Hawtrey argued, the problem is psychological. In response to this situation, when the Bank of Japan introduced "QQE with Yield Curve Control" in September last year, it also introduced an inflation-overshooting commitment (Chart 10). Specifically, the Bank of Japan committed itself to 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 idea is that if people actually experience inflation above 2 percent, inflation expectations will rise through the adaptive component of expectation formation. At the same time, if people experience inflation above 2 percent, this will boost the credibility of the Bank of Japan's price stability target and the formation of inflation expectations will become more forward-looking, helping the Bank of Japan to anchor inflation expectations at about 2 percent. The problems that Japan's economy has faced since the second half of the 1990s were long regarded as specific to Japan. However, following the global financial crisis, which saw the collapse of an asset bubble and severe damage to the financial system, a relatively prolonged slowdown in economic growth and a fall in the inflation rate have become an experience shared by many economies. As a result of the bold response of central banks based on the knowledge and insights gained in the field of economics over the decades, a recurrence of the Great Depression was avoided and global concerns over deflation have faded to a considerable extent. However, the performance of the global economy today is by no means satisfactory. Looking back, monetary policy to work on expectations has played a major role in keeping inflation in check following the bout of high inflation worldwide during the 1970s. The introduction of inflation targeting in many economies since the 1990s as well as the remarkable developments in monetary policy theory implicitly focused on responding to high inflation. While these policies and theoretical developments helped to bring about the Great Moderation, central banks at the same time started to face a new challenge, namely, how to appropriately manage inflation expectations in a low-inflation environment under the zero lower bound. Central bankers and scholars have only just started to find responses to this new challenge, both from a policy and a theoretical perspective. In particular with regard to the inflation expectation formation process, which likely differs across countries, regions, and periods, more empirical analysis is needed. As a central bank, we need to examine concrete measures to appropriately manage inflation expectations based on such analysis. The inflation-overshooting commitment introduced by the Bank of Japan last year is one answer, representing a response to the specific situation in Japan, but I strongly hope that scholars and policy makers will further deepen the debate from a global perspective. British scholars produced sharp insights into the importance of expectations in monetary policy nearly a century ago. Nevertheless, the role of expectations continues to provide challenges -- both old and new -- today. Thank you very much for your attention. The Role of Expectations in Monetary Policy: Evolution of Theories and the Bank of Japan's Experience Speech at the University of Oxford June 8, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Monetary Policy Discussions by Economists in the UK in the First Half of the 20th Century John Maynard Keynes (1883-1946) Liquidity trap “…after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Indeed, owing to the unwillingness of most monetary authorities to deal boldly in debts of long term, there has not been much opportunity for a test.” by Walter Stoneman, bromide print, July 1940 © National Portrait Gallery, London (CC BY-NC-ND 3.0) -- The General Theory of Employment, Interest, and Money Chart 2 Monetary Policy Discussions by Economists in the UK in the First Half of the 20th Century Ralph George Hawtrey (1879-1975) Forward-looking monetary policy “The explanation is that it is not the past rise in prices but the future rise that has to be counteracted. The problem is a psychological one. As soon as the rate is high enough to offset the traders’ hopes of future profits it becomes deterrent. And a very relevant factor in the psychological problem is the traders’ expectations as to the intentions of the authority which fixes rates.” -- Monetary Reconstruction by Walter Bird, bromide print, 1958 © National Portrait Gallery, London (CC BY-NC-ND 3.0) Chart 3 Monetary Policy Discussions by Economists in the UK in the First Half of the 20th Century Ralph George Hawtrey (1879-1975) by Walter Bird, bromide print, 1958 © National Portrait Gallery, London (CC BY-NC-ND 3.0) Effects of interest rate policy “The pressure applied to traders by a moderate rise in the shortterm rate of interest, say, 1 percent, is undeniably very slight. Yet apparently the Bank of England always counted on a rise of 1 percent or even of 0.5 percent having a noticeable effect.” “In the first place, when the use of Bank rate to restrict credit became an established practice, traders, being aware of the intentions of the Bank, were inclined to anticipate them. When Bank rate went up from 3 to 4 percent, a trader would reason that this was intended to have a restrictive effect on markets, and that, if the effect was not brought about, the rate would simply go higher and higher till it was. Those who took that view would restrict their purchases and demand would fall off, and so the 4 percent rate might be found potent enough, even though, if unsupported by traders' anticipations, a 6 or 7 percent rate might have been necessary.” -- A Century of Bank Rate Chart 4 Monetary Policy Discussions by Economists in the UK in the First Half of the 20th Century Announcement effect of monetary policy John Richard Hicks (1904-1989) “I want to use the announcement effect of an act of policy to mean the change which takes place in people's minds, the change in the prospect which they think to be before them, before there is any change which expresses itself in transactions of any kind. It is the same as what Hawtrey calls 'psychological effect'; but that is a bad term, for it suggests something irrational, and this is entirely rational. Expectations of the future (entirely rational expectations) are based upon the data that are available in the present. An act of policy is a significant addition to the data that are available; it should result, and should almost immediately result, in a shift in expectations. This is what I mean by an announcement effect. What I learn from Hawtrey's analysis is that the 'classical' Bank Rate system was strong, or could be strong, in its announcement effects.” Source: All Souls College, University of Oxford -- Economic Perspectives Chart 5 Japan’s Potential Growth Rate y/y % chg. Total factor productivity Capital stock Number of employed Hours worked Potential growth rate -1 -2 FY 83 Note: The potential growth rate is estimated by the Research and Statistics Department, Bank of Japan. Sources: Cabinet Office; Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Ministry of Economy, Trade and Industry; Research Institute of Economy, Trade and Industry. 15 16 Chart 6 Real GDP and Monetary Policy Responses after the Global Financial Crisis Policy Rates Real GDP s.a., 2007/Q1=100 % Japan United States Euro area United Kingdom Japan United States Euro area United Kingdom -1 CY 07 CY 95 Note: For Japan, for the period when no target interest rate was adopted, figures for the policy rate are the interest rate applied on excess reserves. Sources: Cabinet Office; Haver; Bank of Japan; Federal Reserve; European Central Bank; Bank of England. Chart 7 Real Interest Rate and Natural Rate of Interest (Potential Growth Rate) % Real interest rate Potential growth rate Strengthening growth potential -1 FY 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 QQE Notes: 1. The real interest rate is calculated by subtracting the year-on-year rate of increase in the CPI (excluding fresh food and energy) from the yield on 10-year JGBs. Notes: 2. The potential growth rate is estimated by the Research and Statistics Department, Bank of Japan. Sources: Ministry of Internal Affairs and Communications; Bloomberg; Cabinet Office; Bank of Japan; Ministry of Health, Labour and Welfare; Sources: Ministry of Economy, Trade and Industry; Research Institute of Economy, Trade and Industry. Chart 8 Effects of "Quantitative and Qualitative Monetary Easing" Corporate Profits Unemployment Rate s.a., % Ratio of current profits to sales (all industries and enterprises) s.a., % CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 CY00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Hourly Cash Earnings Consumer Prices y/y % chg. 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 y/y % chg. Introduction of QQE (April 2013) -1 -2 CY10 CPI (all items less fresh food and energy) CPI (all items less fresh food) Sources: Ministry of Finance; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 9 Inflation Expectations Contribution of Adaptive Component to Inflation Expectations Synthetic Indicator of Inflation Expectations 2.0 y/y % chg. Beginning of a downtrend in Destabilization of financial crude oil markets amid Consumption prices concern about tax hike emerging Introduction of QQE economies 1.8 1.6 ▼ ▼▼ 1.4 1.0 More adaptive 0.8 ▼ 0.6 1.2 1.0 0.4 0.8 0.6 0.4 0.2 CY07 0.2 Synthetic indicator of firms', households', and economists' inflation expectations 0.0 Japan U.S. Euro area U.K. Note: The chart shows the contribution of observed inflation to inflation expectations 1 year ahead. Sources: Bank of Japan “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). Consensus Economics Inc., "Consensus Forecasts" , etc. Chart 10 Inflation-Overshooting Commitment ・The Bank continues 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. Inflation Rate 2% Expansion of monetary base continues
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Aomori, 22 June 2017.
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June 22, 2017 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Aomori 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 Aomori 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 Aomori 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 The economic growth in Japan has taken hold more firmly since last autumn, and the Bank judges that the economy has been turning from its moderate recovery trend toward a moderate expansion. Looking ahead, from fiscal 2017 through fiscal 2018, improvement in overseas economies and the government's large-scale stimulus measures that were formulated last year are expected to clearly have positive effects on the economy. Under these circumstances, Japan's economy is likely to continue expanding and keep growing at a pace above its potential, mainly through fiscal 2018. In what follows, I would like to talk about the current situation of Japan's economic activity and its outlook in more detail. Let me first touch on overseas economies affecting Japan's economy. In the first half of 2016, pessimistic views about the global economy prevailed; concerns heightened regarding the slowdown in emerging economies including China, and the global financial markets became volatile, triggered by the so-called Brexit. However, the global economy hit bottom in the first half of last year, and its growth momentum seems to have strengthened thereafter, with various economic indicators improving markedly. Specifically, remarkable improvements have been observed in the manufacturing sector and trade activity, both of which had lacked growth momentum after the global financial crisis (Chart 1). Their positive effects have spread globally, and emerging economies -- which tended to lag behind advanced economies -- also have been improving. In the NIEs and the ASEAN economies, for example, although they were sluggish in 2015 and 2016, their exports clearly have picked up and consumer confidence has improved. In China, the economy has continued to see stable growth on the whole, as evidenced by the fact that the year-on-year GDP growth rate for the January-March quarter of 2017 increased somewhat from the previous quarter. Looking forward, growth in emerging economies is expected to become solid on the back of the steady growth in advanced economies and the effects of policy measures taken by emerging economies. The latest World Economic Outlook (WEO) released by the International Monetary Fund (IMF) projects that the global economic growth rate will increase, registering 3.1 percent in 2016, 3.5 percent in 2017, and 3.6 percent in 2018 (Chart 2). The Bank is also monitoring developments in risk factors and their impacts on the global economy; risks include those of the new U.S. administration's economic policy and of political situations in Europe, as well as geopolitical risks. Let me now turn to Japan's economy. Japan's exports and production have been on an increasing trend amid the global improvement mainly in the manufacturing sector and trade activity (Chart 3 [left chart]). Against this background, in the corporate sector, profits have been at record high levels (Chart 3 [right chart]). Business sentiment has been favorable on the whole, and business fixed investment has continued on a moderate increasing trend. A feature of the current economic recovery phase is that improvement in business sentiment has been widely seen, not only for firms in metropolitan areas and large firms but also for firms in local areas and small firms. The diffusion indexes (DIs) by region for business conditions in the Tankan (Short-Term Economic Survey of Enterprises in Japan) have been positive as a trend for all regions since the December 2013 survey (Chart 4). The DIs by firm size have been well above zero for large firms as well as small firms (Chart 5). This was not the case with the previous economic recovery phase from 2002 through 2008 before the global financial crisis. In the household sector, Japan's labor market conditions have continued to tighten steadily. The unemployment rate has declined to the range of 2.5-3.0 percent -- which is virtually full employment -- for the first time since 1994. The active job openings-to-applicants ratio has risen to 1.48 times, the level last seen in 1974, exceeding the peak level observed in the "asset bubble" period (Chart 6). Looking ahead, labor market conditions are expected to tighten further as the economy continues growing at a pace above its potential. In this context, some economists argue that labor shortage may constrain Japan's economic growth. However, I am in dissent with this argument and believe that labor shortage will instead raise labor productivity through, for example, a gradual increase in labor-saving investment, thereby encouraging further economic growth. The tight labor market conditions also have been exerting gradually increasing upward pressure on wages. In fact, the year-on-year rate of change in hourly wages of part-time employees, which are particularly sensitive to labor market conditions, has risen to the range of 2.5-3.0 percent. Furthermore, many firms appear to have raised their base pay for the fourth consecutive year in the annual spring labor-management wage negotiations this year. Base pay rises are especially evident in small and medium-sized firms that face acute labor shortage, amid improvement in business conditions spreading beyond large firms (Chart 7). Next, I will talk about price developments. Although a decline in energy prices since the second half of 2014 had exerted downward pressure on consumer prices, such pressure dissipated and energy prices turned toward pushing up general prices. The year-on-year rate of change in the consumer price index (CPI) excluding fresh food has been slightly positive since January 2017. Meanwhile, that in the CPI excluding fresh food and energy has continued to be positive as a trend for around three and a half years (Chart 8). Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in prices. Nevertheless, we must admit that Japan's inflation has been relatively moderate, despite the fact that corporate profits have been at record high levels and the labor market has been at virtually full employment. This is in striking contrast to the situations in the United States and Europe, where inflation rates have already recovered significantly (Chart 9 [left chart]). What lies behind such moderate inflation is the fact that, in Japan, people's perception of future price developments -- that is, inflation expectations -- tends to be largely affected by actual inflation rates, which declined in the past. This largely adaptive formation mechanism of inflation expectations is unique to Japan, and is rarely observed in other major economies. In fact, despite the global fall in crude oil prices, inflation expectations in the United States and Europe have barely declined (Chart 9 [right chart]). This is because the degree to which inflation expectations are affected by past inflation is smaller in these economies. What creates such differences? My answer is that the forecasts of prices based on past inflation have performed well in Japan, as the inflation rate was persistently low for a long time during the deflationary period since the second half of the 1990s. During this period, if the actual inflation rate in the previous year was 0 percent, for example, it was reasonable to project that the inflation rate would be 0 percent again in the following year, rather than rise to 2 percent. However, Professor Milton Friedman -- a distinguished scholar of economics -- made the following argument, stating that how inflation expectations are formed among the public is subject to change. If wages are unchanged in a situation of continued inflation, employees' real income will be lost to the extent of inflation. They would not tolerate such a situation forever; rather, they eventually will start to forecast future inflation in a forward-looking manner and demand wage increases based on the forecast. This is an example for wages, but the same mechanism will be in place for retail prices of products and services; in an inflationary phase, firms will start to anticipate future inflation and raise their retail prices based on their forecast. As for the outlook, the year-on-year rate of increase in consumer prices is expected to accelerate, as upward pressure on wages heightens amid a further tightening of labor market conditions, and as a positive contribution of energy prices to inflation increases. Friedman's argument suggests that, during this inflationary phase, inflation expectations in Japan will become less affected by past inflation, with a gradually increasing number of people formulating their inflation expectations in a forward-looking manner, as is the case in the United States. Furthermore, as I will talk about more later, the Bank will continue to pursue powerful monetary easing with the aim of achieving its price stability target of 2 percent. Against this backdrop, although uncertainty about future developments in inflation expectations warrant attention, Japan's inflation rate is likely to gradually increase toward the price stability target of 2 percent. II. Thinking behind the Conduct of Monetary Policy Next, I would like to talk about the thinking behind the Bank's conduct of monetary policy. Since last September, the Bank has been conducting monetary policy under the framework of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control." This framework consists of two components (Chart 10). The first is an inflation-overshooting commitment. This is the Bank's strong 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. You may wonder why monetary easing will be continued until the inflation rate exceeds, not just reaches, 2 percent. In Japan, the view that prices will not increase -- the so-called deflationary mindset -- has been entrenched among people under prolonged deflation. It is crucial, therefore, that the public actually experience inflation above 2 percent 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 has committed itself to continue with large-scale monetary expansion until such situation is achieved through this inflation-overshooting commitment. The second component is yield curve control. Under yield curve control, the Bank has been facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent, taking account of developments in Japan's economic activity and prices as well as financial conditions. At present, 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. As I explained earlier, although the economic growth in Japan has taken hold more firmly, the inflation momentum is not yet sufficiently firm and there is still a long way to go before achieving the price stability target of 2 percent. Risks have continued to be skewed to the downside, particularly those regarding developments in overseas economies and in firms' and households' medium- to long-term inflation expectations. Under these circumstances, I believe that it is necessary that the Bank persistently pursue monetary easing under "QQE with Yield Curve Control," aiming to lower real interest rates, taking advantage of lowered nominal interest rates. Now I would like to bring up my views on two proposals recently heard from some economists on the Bank's conduct of monetary policy. The first proposal is that the Bank should start raising interest rates, as the global environment surrounding interest rates has been changing against the background of the global economic growth gaining momentum and the Federal Reserve pushing forward the rate hike process. As often pointed out, nominal interest rates in Japan of late are lower than those in the United States for both short and long maturities (Chart 11). However, it is not nominal but real interest rates -- calculated by subtracting inflation expectations from nominal interest rates -- that determine monetary easing effects on the economy. With this in mind, if recent real interest rates in Japan are compared with those in the United States, it is evident that long-term real interest rates are lower in Japan while short-term real interest rates are higher. This is because inflation expectations are lower in Japan than in the United States. In other words, unlike nominal interest rates, it is not necessarily the case that real interest rates in Japan are significantly lower than those in the United States. Moreover, while the inflation rate in the United States already has been close to 2 percent, in Japan there is still a long way to go to achieve the price stability target of 2 percent. This means that monetary easing is still necessary in Japan in light of achieving the price stability target, and I do not think at all that it is time that we reduce the level of monetary accommodation, which may not be very high at present compared to that in the United States, by raising interest rates. The second proposal is with regard to the Bank's price stability target of 2 percent. Some economists argue that there may be no need to aim at higher inflation than the current level as Japan's economic growth rate has been increasing, or that 1 percent -- instead of 2 percent -- is appropriate for Japan's price stability target level since the inflation rate does not accelerate easily in Japan. To argue against this kind of proposal, let me look back on short-term interest rate developments in the United States and Japan since the outbreak of the global financial crisis. When an economy suffers from a negative shock and demand declines significantly, as was the case following the global financial crisis, it is crucial to reduce real interest rates sufficiently to stop the decline in demand and work toward its prompt recovery. From this perspective, both the Federal Reserve and the Bank of Japan conducted monetary easing after the global financial crisis, thereby reducing short-term nominal interest rates to almost 0 percent (Chart 12). However, developments in real interest rates, which are a determinant of monetary policy effects, show that while short-term real interest rates in the United States declined significantly after the global financial crisis and remained in negative territory thereafter, those in Japan actually increased and stayed in positive territory. It was not until the introduction of QQE in 2013 that short-term real interest rates in Japan started to follow a declining trend, entering and then remaining in negative territory. As we have just seen, even though short-term nominal interest rates in Japan and the United States were reduced to 0 percent, the level of short-term real interest rates in Japan was higher than that in the United States. This is due to the difference in the levels of inflation expectations, which are subtracted from nominal interest rates in calculating real interest rates. Although inflation expectations declined both in the United States and Japan right after the global financial crisis, you will find striking differences between these two economies in developments following the crisis. In the United States, the extent of decline was only marginal; inflation expectations soon bottomed out and have been at around 2 percent in a stable manner. In Japan, inflation expectations -- which had been much lower than those in the United States even before the global financial crisis -- declined to a large extent, and thereafter remained in negative territory for a prolonged period until 2013. This explains why short-term real interest rates in Japan remained higher than those in the United States. By the same token, the main reason why the differential between long-term real interest rates in Japan and those in the United States was far narrower than the differential between long-term nominal interest rates for the two is because inflation expectations in Japan remained lower than those in the United States (Chart 13). In Japan, where inflation expectations are low and tend to decline further in a recession period especially, real interest rates cannot be lowered sufficiently to provide appropriate monetary accommodation, even with nominal interest rates of 0 percent. In contrast, in the United States, where inflation expectations have been stable at around 2 percent, a reduction in nominal interest rates will result in a sufficient decline in real interest rates, providing adequate monetary accommodation. In other words, without reducing nominal interest rates to negative territory as in Japan, sufficient monetary easing effects can be obtained in the United States while alleviating impacts on financial institutions of low interest rates. Although the epicenter of the global financial crisis was outside of Japan, its economy suffered a more significant downturn thereafter than did those of the United States and Europe (Chart 14). Moreover, the price stability target of 2 percent has not been achieved yet despite the large-scale monetary easing since the introduction of QQE in 2013. It is undeniable that one of the most important factors behind this is that there was limited room for a reduction of real interest rates -- or for monetary easing -- in Japan, as inflation expectations stayed at low levels, or declined significantly, after the global financial crisis. With these factors in mind, the Bank has been conducting monetary policy to achieve the price stability target of 2 percent, with a view to creating an environment where real interest rates can be lowered sufficiently and thereby the economy can be supported effectively even when adverse shocks hit the economy. The price stability target is set at around 2 percent in many major economies, including Japan. This is because of the view shared globally that it is important to anchor inflation expectations at 2 percent and to secure sufficient room for a reduction of real interest rates, by keeping the inflation rate stable at around 2 percent. Therefore, when I hear the kind of arguments in Japan that we do not need to aim at 2 percent inflation, I wonder whether people have already forgotten the very important lesson learned from the hard times after the global financial crisis, as nearly a decade has passed since then. The Bank will pursue powerful monetary easing with the aim of achieving the price stability target of 2 percent at the earliest possible time. Conclusion In conclusion, let me touch on the economy of Aomori Prefecture. The prefecture can be characterized by prosperous agricultural, forestry, and fishery industries with rich nature, as well as a variety of natural, historical, and cultural tourist attractions. In the agricultural, forestry, and fishery industries, the prefecture is Japan's largest producer of many items such as apples and garlic, with a large-scale and modern business project expanding in the livestock industry in recent years. Despite nationwide sluggishness in these industries, Aomori Prefecture's production is on the rise, at a growth level that is one of the highest among all prefectures. The industries have been taking initiatives recently to raise the value added through enhancement of the products' brand images as well as the "sixth industrialization," and proceeding with overseas expansion of their businesses. Steady progress has been made already; "Seiten no hekireki" is gaining attention as a new rice brand and "Kuro ninniku," or black garlic, has been increasingly sold in Europe and the United States. In the tourist industry, the prefecture is endowed with various attractions such as the natural environment and its historical and cultural heritage: the Shirakami Mountains, which are registered as a world heritage site; Hirosaki Castle, which is also famous for cherry blossoms; Jomon period archeological sites; and the Nebuta Festival. On top of these, taking advantage of the launch of the Hokkaido Shinkansen last year, the prefecture has been enhancing tourism promotion in cooperation with the Hakodate area. It also has been making great efforts in boosting inbound demand. With these initiatives, the recent growth rate in the number of accommodated inbound guests has marked one of the highest figures nationwide. The number of cruise ships calling at ports in the prefecture is higher than that in any other prefectures in the Tohoku region, and more foreign visitors are expected as regular international flights have been in operation at Aomori Airport since this May for the first time in 22 years. I believe that people in Aomori Prefecture are taking on new challenges, making full use of these rich resources. I expect the Bank's Aomori Branch to support these initiatives through analysis of the local economy and communication with the public. In closing, let me express my strong hopes for the further development of Aomori Prefecture's economy and convey my best regards. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Aomori June 22, 2017 Kikuo Iwata Deputy Governor of the Bank of Japan Chart 1 Overseas Economies 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 2 World Economic Outlook Released by the IMF Projections for Major Economies (as of April 2017) y/y % chg. [Projections] [Projections] 3.4 3.1 3.5 3.6 Advanced Economies 2.1 1.7 2.0 2.0 United States 2.6 1.6 2.3 2.5 Euro Area 2.0 1.7 1.7 1.6 United Kingdom 2.2 1.8 2.0 1.5 Emerging Market and Developing Economies 4.2 4.1 4.5 4.8 China 6.9 6.7 6.6 6.2 ASEAN5 4.8 4.9 5.0 5.2 World Note: ASEAN5 are Indonesia, Malaysia, the Philippines, Thailand, and Viet Nam. Source: IMF. Chart 3 Exports, Industrial Production, and Corporate Profits Corporate Profits Exports and Industrial Production s.a., % s.a. Real exports (CY 2015=100) Ratio of current profits to sales (all industries and enterprises) Industrial production (CY 2010=100) CY10 CY01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for corporate profits are based on the "Financial Statements Statistics of Corporations by Industry, Quarterly." Excluding "Finance and Insurance." Sources: Bank of Japan; Ministry of Finance; Ministry of Economy, Trade and Industry. Chart 4 Business Conditions by Region (Tankan) DI ("favorable" - "unfavorable"), % points "Favorable" "Unfavorable" -10 -20 -30 Range of responses by region Tohoku region -40 Japan (all industries and enterprises) -50 -60 CY 05 Source: Bank of Japan. Chart 5 Business Conditions by Size of Enterprise (Tankan) DI ("favorable" - "unfavorable"), % points Large enterprises Medium-sized enterprises Small enterprises "Favorable" "Unfavorable" -20 -40 -60 CY 84 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 17 Note: There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: Bank of Japan. Chart 6 Labor Market Conditions Unemployment Rate and Active Job Openings-to-Applicants Ratio s.a., times s.a., % Unemployment rate (left scale) Active job openings-to-applicants ratio (right scale) 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 CY 05 0.3 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 7 Nominal Wages Scheduled Cash Earnings (Full-Time Employees) Hourly Cash Earnings y/y % chg. 2.0 3.0 y/y % chg. Composition effect, etc. 2.5 Establishments with 100 or more employees Establishments with less than 100 employees Total (5 or more employees) 1.5 2.0 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -0.5 Hourly cash earnings -1.0 -0.5 Hourly scheduled cash earnings (part-time employees) -1.5 -2.0 -1.0 17 CY 95 Note: For hourly cash earnings, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures for 2017/Q1 are those of March-April averages. Source: Ministry of Health, Labour and Welfare. 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 Consumer Prices and Inflation Expectations in Advanced Economies Inflation Expectations (Long-term) Consumer Prices (All Items) % % Japan Japan -1 United States United States Euro area Euro area -2 CY10 Beginning of a downtrend in crude oil prices CY 10 Notes: 1. Figures for Japan's CPI (all items) are adjusted to exclude the estimated effects of changes in the consumption tax rate. 2. Figures for inflation expectations (long-term) are 6-10 years ahead expectations in the "Consensus Forecasts." Sources: Ministry of Internal Affairs and Communications; BEA; Eurostat; Consensus Economics Inc., "Consensus Forecasts." Chart 10 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 2% 0.6 0.4 Target level of the long-term interest rate "around zero percent" Short-term policy interest rate "minus 0.1 percent" 0.2 0.0 -0.2 -0.4 Expansion of monetary base continues Source: Bloomberg. 0 1 year 9 10 15 20 Residual maturity Nominal and Real Interest Rates (the Most Recent) (1) Short-term (overnight) Inflation Expectations % Real Interest Rates （≒Observed Inflation Rates) Nominal Interest Rates % -1 -1 -1 -2 -2 -2 Japan Japan United States Chart 11 % United States Japan United States (2) Long-term (10-year) Inflation Expectations Nominal Interest Rates % % Real Interest Rates -1 -1 -1 -2 -2 Japan United States % -2 Japan United States Japan United States Notes: 1. Figures are those of April 2017. Figures for observed inflation rates are the CPI (all items less fresh food and energy) for Japan and the PCE deflator (all items less food and energy) for the United States. 2. Figures for long-term inflation expectations are 6-10 years ahead expectations in the "Consensus Forecasts." Sources: Ministry of Internal Affairs and Communications; Consensus Economics Inc., "Consensus Forecasts"; Bloomberg; BEA. Chart 12 Short-term Interest Rates (O/N) after the Global Financial Crisis Inflation Expectations Nominal Interest Rates % United States Bankruptcy of Lehman Brothers % Japan Japan Real Interest Rates (≒Observed Inflation Rates) United States % Japan United States -1 -1 -2 -2 -1 CY 07 08 09 10 11 12 13 14 15 16 17 -3 CY 07 08 09 10 11 12 13 14 15 16 17 -3 CY 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for observed inflation rates are the CPI (all items less fresh food and energy, adjusted to exclude the estimated effects of changes in the consumption tax rate) for Japan and the PCE deflator (all items less food and energy) for the United States. Sources: Bloomberg; Ministry of Internal Affairs and Communications; BEA. Chart 13 Long-term Interest Rates (10-Year) after the Global Financial Crisis Nominal Interest Rates % Real Interest Rates Inflation Expectations % Japan Bankruptcy of Lehman Brothers Japan United States Japan United States -1 -1 -2 % United States -1 -2 CY 07 08 09 10 11 12 13 14 15 16 17 CY 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for inflation expectations are 6-10 years ahead expectations in the "Consensus Forecasts." Sources: Bloomberg; Consensus Economics Inc., "Consensus Forecasts." -3 CY 07 08 09 10 11 12 13 14 15 16 17 Chart 14 Developments in Real GDP after the Global Financial Crisis s.a., 2007/Q1=100 Bankruptcy of Lehman Brothers Japan United States CY07 Euro area Sources: Cabinet Office; BEA; Eurostat.
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Hiroshima, 26 July 2017.
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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, Hiroshima, 26 July 2017. * * * Accomompanying slides. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Hiroshima 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 Hiroshima Branch. At the Monetary Policy Meeting (MPM) held last week, the Bank formulated its projections, such as for Japan’s economic activity and prices through fiscal 2019, and released them in the July 2017 Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to talk 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 Report. I. Recent developments in and outlook for economic activity Overseas economies Let me start by talking about developments in economic activity. I would first like to touch on developments in overseas economies. Overseas economies have continued to grow at a moderate pace on the whole (Chart 1). In particular, remarkable improvements have been observed in the manufacturing sector and trade activity, and their positive effects have spread globally. Indicators of business sentiment in the manufacturing sector have been on an improving trend in many economies since the second half of 2016, and trade volumes have accelerated their pace of increase recently on a global basis, mainly for the United States and Asia. By region, the U.S. and European economies have continued to recover firmly, mainly in the household sector, particularly owing to an improvement in the employment and income situation. The Chinese economy has continued to see stable growth on the whole, partly due to the effects of authorities’ measures to support economic activity. Under such circumstances, other emerging economies and commodity-exporting economies have picked up on the whole, particularly reflecting a pick-up in exports and a bottoming out of commodity prices. Positive developments have started to be observed in Russia and Brazil, for which economic recovery had been lagging behind. With regard to the outlook, the growth rates of overseas economies are expected to increase moderately as advanced economies continue growing steadily and a recovery in emerging economies takes hold on the back of the steady growth in advanced economies and the effects of policy measures taken by emerging economies. Looking at the weighted averages of the International Monetary Fund’s (IMF’s) July 2017 projections for real GDP growth rates of individual economies and regions, by value of exports from Japan, the growth rates of overseas economies are projected to increase moderately through 2018 from 3.1 percent in 2016, and remain stable at around 3.5 percent. 1/8 BIS central bankers' speeches Recent developments in Japan’s economic activity Japan’s economy is expanding moderately, strongly supported by such growth in overseas economies, along with an increase in domestic demand (Chart 2). It is the first time in about nine years — since March 2008, that is, before the collapse of Lehman Brothers — that the Bank assesses the current situation of the economy as “expanding.” This assessment is based on the fact that, with a virtuous cycle from income to spending operating, the output gap that shows the utilization of capital and labor has exceeded the long-term average of 0 percent and that a positive output gap has taken hold. Let me elaborate on this point. First, in the corporate sector, exports have been on an increasing trend on the back of a pick-up in emerging economies, and production also has been on an increasing trend reflecting an increase in demand both at home and abroad (Chart 3). In this situation, corporate profits have improved, and the ratio of current profits to sales for all industries and enterprises marked a record high level for two consecutive quarters since the OctoberDecember quarter of 2016. It was reconfirmed in the Bank’s June 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) released at the beginning of July that business sentiment has improved, and across a wider range of industries, as seen in the diffusion index (DI) for business conditions for all industries and enterprises having improved for four consecutive quarters. Under such a favorable environment, business fixed investment has been on a moderate increasing trend. Turning to the household sector, supply-demand conditions in the labor market have continued to tighten steadily and employee income has increased moderately (Chart 4). The active job openings-to-applicants ratio for May 2017 stands at 1.49 times, exceeding the highest figure during the bubble period and reaching a level last seen in 1974. The unemployment rate has declined to around 3 percent recently, which shows that the employment situation has remained close to full employment. Against the background of such tightening of labor market conditions, wages have risen moderately. In particular, the year-on-year rate of increase in hourly scheduled cash earnings of part-time employees has seen a clear improvement, being in the range of 2.02.5 percent of late. Meanwhile, with regard to private consumption, although relatively weak developments had been seen in some of its indicators through the first half of 2016, it has picked up thereafter and has increased its resilience recently (Chart 5). Although replacement demand for durable goods such as automobiles and household electrical appliances is pushing up private consumption to a certain degree, a steady improvement in the employment and income situation — including its effects on consumer sentiment — is likely to be substantially contributing to growth in private consumption. Outlook for Japan’s economic activity Next, I would like to turn to the Bank’s outlook for Japan’s economic activity. Japan’s economy is likely to continue its moderate expansion. Specifically, exports are expected to continue their moderate increasing trend backed by an improvement in overseas economies, and business fixed investment and private consumption are projected to follow an increasing trend on the back of highly accommodative financial conditions and the effects of the government’s large-scale stimulus measures. Japan’s economy is likely to see sustainable expansion in a well-balanced manner in which demand at home and abroad increases with a virtuous cycle from income to spending being maintained. In the July 2017 Outlook Report, the medians of the Policy Board members’ forecasts of the real GDP growth rates for fiscal 2017 and fiscal 2018 are 1.8 percent and 1.4 percent, respectively (Chart 6). These rates are revised somewhat upward from the projections made three months ago, being above the potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. In fiscal 2019, the growth pace is projected to decelerate, mainly reflecting cyclical adjustments in capital stock after the prolonged economic expansion, Olympic Games-related demand peaking out, and the effects of the scheduled consumption tax hike. Nevertheless, the economy is expected to continue expanding, supported by the increase in 2/8 BIS central bankers' speeches exports on the back of the growth in overseas economies, and the median of the real GDP growth rate for fiscal 2019 is 0.7 percent. There are, of course, upside and downside risks to this baseline scenario of the outlook for Japan’s economic activity. The biggest risk factor is developments in overseas economies. As I have explained, the main scenario is that the growth rates of overseas economies are expected to increase moderately, but it is subject to various uncertainties. For example, with regard to the U.S. economic policies, heightened uncertainties concerning fiscal policy and the impact of the pace of the policy interest rate hike on global capital flows warrant attention. The following are also considered as risks: developments in emerging and commodity-exporting economies; negotiations on the United Kingdom’s exit from the European Union (EU) and their effects; prospects regarding the European debt problem, including the financial sector; and geopolitical risks. If these risks were to materialize, they could exert downward pressure on economic activity. Therefore, the Bank will continue examining these developments thoroughly. II. Price developments and their outlook Price developments Let me move on to the price developments in Japan. Although energy prices had exerted downward pressure on prices since the second half of 2014, they have been pushing up prices reflecting a pick-up in crude oil prices since last spring. Against this backdrop, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food turned positive in January 2017 for the first time in 13 months, and rose to 0.4 percent in May (Chart 7). Nevertheless, when excluding the effects of energy prices, price developments in Japan have been relatively weak. The year-on-year rate of increase in the CPI excluding fresh food and energy has remained on a decelerating trend after marking a peak of 1.2 percent at end-2015, and has been at around 0 percent lately. This is partly attributable to temporary factors such as a reduction in sales prices of and charges for mobile phones. However, as I will explain later, the fact that increases in wages and prices have been sluggish, despite tight labor market conditions and high corporate profits, also affects price developments. Outlook for prices As I have explained, the recent developments in prices have been relatively weak. However, I believe that we can expect to see a turnaround in such developments going forward. Specifically, the year-on-year rate of change in the CPI is likely to continue on an uptrend and increase toward 2 percent, which is the Bank’s price stability target. This is expected to be realized through the following mechanism. First, prices of items such as processed food and daily necessities — which are responsive to economic activity — are likely to rise gradually as private consumption increases its resilience, and the yen’s depreciation as well as the pick-up in crude oil prices to date are expected to push up import prices. Second, as the economy continues to expand, the output gap is expected to widen further within positive territory and remain positive. Under such circumstances, firms’ stance is likely to gradually shift toward raising wages and prices, and the inflation rate is projected to rise accompanied by wage increases (Chart 8). Third, with these factors pushing up actual inflation rates, people’s inflation expectations are also expected to rise accordingly, leading to an increase in the underlying trend in inflation. Based on the underlying scenario that I just explained, the July Outlook Report presents that the medians of the Policy Board members’ forecasts for the year-on-year rate of change in the CPI 3/8 BIS central bankers' speeches excluding fresh food are 1.1 percent for fiscal 2017, 1.5 percent for fiscal 2018, and on a basis excluding the effects of the consumption tax hike, 1.8 percent for fiscal 2019 (Chart 6). As the recent price developments have been relatively weak, the forecasts for fiscal 2017 and fiscal 2018 in particular were revised downward from those presented in the previous Outlook Report three months ago. The year-on-year rate of change in the CPI will likely reach about 2 percent around fiscal 2019. Relationship among labor market conditions, wages, and prices So far, I have explained Japan’s economic activity and prices. This can be briefly summarized as somewhat strong economic activity and relatively weak prices. That being said, I believe the question that many would pose is why the rates of increase in wages and prices are not rising despite the moderate economic expansion — especially when labor market conditions have tightened so acutely that the issue of labor shortage has been covered by the media day after day. Another question is whether the mechanism for higher inflation, which I just mentioned, would operate as intended. Although both are difficult questions, I would like to offer possible answers to them, while focusing on the relationship among labor market conditions, wages, and prices in Japan. To begin with, from a theoretical point of view, the fact that there is a correlation between labor market conditions and prices can be found in almost every economic textbook, and also can be confirmed based on historical data in Japan. The following mechanism is assumed to be in place. First, firms that have come to face a labor shortage would raise wages in order to secure the number of employees needed. Then, in order to secure a certain level of profits, these firms are likely to consider raising their products’ sales prices in light of the rise in labor costs. At the same time, another possible channel for raising prices is that, when wages increase, employee income would increase and consumption activity would rise accordingly, leading to a raising of prices in reflection of an increase in demand. As this shows, the tightening of labor market conditions essentially would push up prices through increases in wages and demand. In other words, such a theoretical mechanism is not operating sufficiently in Japan’s economy today. In what follows, I would like to consider this point from two aspects, first touching on the relationship between labor market conditions and wages, and then that between wages and prices. The first point is that the pace of improvement in wages has remained only moderate despite the tightening of labor market conditions. This is likely to be attributable to a certain degree to the structure of Japan’s labor market, in which the wage-setting mechanism between full-time and part-time employees is different. As I explained earlier, wages of part-time employees are rising in response to the tightening of labor market conditions, and the pace of increase is almost in line with the relationship between wages of part-time employees and labor market conditions observed in the past. On the other hand, wages of full-time employees are not rising as much as those of part-time employees (Chart 9). As a reason for this, some point to the fact that since both labor and management in Japan have been placing priority on the long-term stability of employment and wages over wage increases, the following has been observed: employment adjustment and wage reductions had rarely been conducted even under deflation, and firms’ stance can hardly shift toward raising wages even if labor market conditions tighten. The second point is the relationship between wages and prices; namely, that the recent developments in prices have been relatively weak, although nominal wages have been rising, albeit at a moderate pace (Chart 10). This can be explained by the following three cases of firms’ initiatives. First, it has been pointed out that these developments reflect firms’ initiatives to absorb a rise in costs resulting from wage increases by streamlining their business process. Specifically, firms recently appear to be increasingly cutting back services for which labor costs are high in light of 4/8 BIS central bankers' speeches profitability, even those that had been taken for granted thus far. For example, even in the case of a discontinuation of business late at night and early in the morning, at which time sales are low, reducing business hours — or the amount of labor input — might not lower sales as much. This results in a rise in labor productivity. Even if hourly wages of employees are raised, firms’ overall labor costs would not rise due to the reduction in business hours. In this case, firms would not have to pass on the rise in labor costs to sales prices, and thus the upward pressure on prices would be limited accordingly. Second, labor-saving and efficiency-improving investment that makes use of information technology is likely to bring about similar effects to those explained earlier. In recent years, such items as self-checkout machines and online reservation systems have been widely introduced, mainly in sectors such as “retailing” and “accommodations, eating and drinking services.” This would produce the same effects as streamlining of the business process, in that the same amount of sales can be realized even with a reduced amount of labor input, and also would result in a rise in labor productivity. As the effects of raising employees’ wages on the overall labor costs are limited, wage increases would not necessarily lead to inflation, as was the case earlier. Third, it also can be pointed out that firms are trying to make better use of existing human resources. A typical example is to reallocate employees to divisions that have relatively high work demand from those with low work demand. In such a case, labor productivity will improve because firms increase their sales without having to increase the total amount of labor input. The pass on to sales prices would be limited as a rise in labor costs is constrained. In further examining the background to these initiatives that I have just mentioned, what appears to lie behind them is the mindset and behavior based on the assumption that wages and prices will not increase easily, having been deeply entrenched among firms and households in Japan. It is a well-known fact that wages of full-time employees are not so responsive to developments in labor market conditions due to the relationship between labor and management over the years, which is specific to Japan, including base pay increases. In addition, consumers are not used to price rises and firms become cautious in raising prices in expectation of consumers’ response to price rises; this seems to be a reason why firms refrain from passing on cost increases to sales prices. As I mentioned earlier, firms’ initiatives to absorb a rise in labor costs lead to a reduction in upward pressure on prices in the economy as a whole. There is no doubt that each initiative is the outcome of firms’ earnest and reasonable decision-making, though. This situation might reflect the difficulty in dispelling the deflationary mindset that has been entrenched among people for a long period. That being said, I would like to add that the Bank does not hold the view that this situation will last forever. The output gap has been improving steadily, and under such circumstances, firms’ stance is likely to gradually shift toward raising wages and prices. We should not be optimistic, given that the timing of manifestation of this stance is uncertain. However, it might be difficult for firms to address the labor shortage going forward only by increasing the number of part-time employees in particular, given that the employment rate already has increased significantly amid the labor shortage intensifying. In fact, the ratio of part-time employees in Japan, which had been on the rise for more than ten years, has shown a clearer trend of peaking out since the turn of the year (Chart 11). There is a certain limit to a reduction in business hours and a cutback in services, and it is not the case that labor-saving investment can be promoted in all industries. Initiatives such as reallocation of employees have their limit. That being said, if households’ consumption is stimulated, reflecting economic expansion and an improvement in the employment and income situation, price rises will be widely accepted across the entire economy. The DI for output prices in the June 2017 Tankan shows that an increasing trend in sales prices has become widely evident in labor-intensive sectors such as “transport and postal activities,” “wholesaling and retailing,” and “accommodations, eating and drinking services” (Chart 12). Recently, it is reported more frequently that the number of firms that are considering raising prices going forward is on the increase. 5/8 BIS central bankers' speeches If actual prices start to rise reflecting these developments, medium- to long-term inflation expectations are expected to increase accordingly. Recently, some indicators have started to show that firms’ and households’ inflation expectations are rising, which also serves as a positive factor for overcoming deflation (Chart 13). Once an expectation that prices will go up is shared widely among firms and households, a rise in wages of full-time employees will be observed clearly and it will become easier for firms to pass on wage increases to sales prices. I am convinced that, if that happens, a virtuous cycle between an increase in wages for a wide range of employees and a sustainable rise in the inflation rate will start operating fully. Before I conclude this part of my speech, I would like to touch on labor productivity once again. While giving you labor-saving investment as an example, I explained that a rise in labor productivity has been exerting downward pressure on prices. However, that only explains part of its impact on prices. I do not intend at all to say that an improvement in labor productivity should be viewed negatively. If the value-added per worker increases along with an improvement in productivity, firms’ profitability will be enhanced accordingly. From a somewhat longer-term perspective, once firms have additional profits, they will start to consider raising wages in a manner that is consistent with an improvement in productivity. In fact, when analyzing developments in base pay increases in recent years, it can be observed that a rise in labor productivity leads to an acceleration in base pay increases. Moreover, if labor productivity of the economy as a whole improves and the long-term economic growth rate rises, business fixed investment and private consumption are likely to be stimulated through rises in growth expectations and permanent income, and prices are expected to rise with the improvement in the output gap. Although it would take time, structural policies also will support this path. For example, if labor market reform makes it possible to smoothly reallocate needed staff to firms and industries that face a labor shortage, productivity of the economy as a whole will increase. It is said that there is greater room for improvement in mobility in Japan’s labor market compared with other major economies, and this implies that the government’s initiatives of late — including working-style reforms — are very meaningful. Thus, the current labor shortage can be described as having an aspect of the ultimate growth strategy for Japan’s economy to powerfully urge its structural reform. III. The Bank’s conduct of monetary policy So far, I have explained the reasons why prices are not rising as much despite the tightening labor market conditions. In this regard, some of you may ask why the Bank is aiming at a rise in prices. Rather, it may be natural to believe that lower goods prices are favorable. Therefore, in explaining the Bank’s conduct of monetary policy, I would like to start with the reason why the Bank is aiming at a situation in which prices rise in a stable manner. Under deflation, or a sustained decline in prices, a decline in prices of goods and services leads to a decrease in firms’ sales and profits, which in turn results in wage restraint. Consequently, the economy falls into a vicious cycle where sluggish consumption leads to a further decline in prices. On the other hand, the opposite cycle would arise if prices rise in a stable manner, and firms and households start to behave based on this assumption. If firms’ sales and profits increase due to rises in prices of goods and services, wages would increase accordingly, leading to more active consumption. What the Bank is aiming at is realizing such a virtuous cycle, and this consequently would bring about benefits to a wide range of economic entities. What is important is that prices rise in a stable manner. The Bank considers the annual rate of increase in the inflation rate of around 2 percent to represent a “stable manner,” and sets this as the target of monetary policy conduct. We sometimes receive comments that the 2 percent inflation target is too high, perhaps given that recent economic activity is already firm. However, we believe that it is crucial to aim at 2 percent for the following three reasons. First, the CPI has a statistical tendency of demonstrating a higher inflation rate than the actual 6/8 BIS central bankers' speeches one. Therefore, in order to actually ensure price stability, the inflation rate should be sufficiently positive. Second, the policy response needs a buffer to a certain extent. In order not to fall into deflation again, it is desirable to ensure that the inflation rate be positive to some extent. In general, a central bank can respond to higher inflation by raising its policy interest rate. On the other hand, in the case of deflation, despite the central bank’s efforts to stimulate the economy, it is difficult to lower the policy interest rate substantially below 0 percent, and room for the monetary policy response as a tool for macroeconomic policy would be limited. Third, the 2 percent target is a global standard. Major advanced economies set the target level of inflation rate at 2 percent. When relevant economies aim at the same target level, it will contribute to the stability of foreign exchange rates in the long run as well as that of corporate activities and the economy as a whole. The Bank has conducted “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control” since September 2016 with a view to achieving the price stability target of 2 percent. The framework of this policy consists of two components (Chart 14). The first 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 actual CPI exceeds 2 percent and stays above that level in a stable manner. It is crucial that people actually experience inflation above 2 percent and thereby the perception takes hold among them that prices of goods and services tend to go up every year by around 2 percent. The second component is yield curve control. Under yield curve control, the Bank has been facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent at the earliest possible time, taking account of developments in Japan’s economic activity and prices as well as financial conditions. Specifically, 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. Based on this yield curve, issuance rates for CP and corporate bonds have remained at extremely low levels. Financial institutions’ lending attitudes have been proactive, and lending rates have declined to around historical low levels. In these circumstances, the year-on-year rate of increase in the amount outstanding of bank lending has accelerated at a moderate pace to the range of 3.0-3.5 percent. Meanwhile, firms’ financial positions have improved for all firm sizes. These developments suggest that accommodative financial conditions brought about by yield curve control have been strongly supporting corporate activities in Japan. As I have explained thus far, price developments in Japan have been relatively weak compared with the improvement seen in economic activity, and there is still a long way to go to achieve the price stability target of 2 percent. We are well aware that the Bank should take this point seriously. Going forward, firms’ stance is likely to gradually shift toward raising wages and prices with the steady improvement in the output gap. Medium- to long-term inflation expectations are projected to rise steadily as further price rises come to be observed widely with some indicators of such expectations showing a rise. As such, the momentum toward achieving the price stability target of 2 percent is maintained firmly. Therefore, in order to maintain these positive developments and achieve the price stability target of 2 percent at the earliest possible time, the Bank will persistently pursue the current powerful monetary easing. I believe that the Bank’s monetary policy and the government’s structural policy working perfectly in line with each other will bring Japan’s economy back to a sustainable growth path. Conclusion So far, I have explained the developments in economic activity and prices in Japan as well as the 7/8 BIS central bankers' speeches Bank’s policy response. To conclude, I would like to talk about some of my impressions of the economy of Hiroshima Prefecture. Hiroshima Prefecture’s economy is currently expanding moderately. Exports are picking up on the back of growth in overseas economies, and private consumption is increasing its resilience against the backdrop of a steady improvement in the employment and income situation. Reflecting the increase in demand both at home and abroad, production is increasing at a moderate pace. Hiroshima Prefecture’s active job openings-to-applicants ratio marked 1.77 times in May, which suggests that labor market conditions of the prefecture are tighter than those of Japan as a whole. Under such circumstances, local firms are devising various ways to address the labor shortage, such as the introduction of automated systems that utilize the excellent technologies and ideas developed over the years — even in areas in which automation had been regarded as impossible. In addition, in the automobile industry — the main industry of this prefecture — bold efforts are being made to introduce new technologies with the aim of responding to stricter environmental regulations and further improving safety. As I mentioned earlier, if the value-added per worker increases thanks to such initiatives, firms’ productivity will improve and their profitability will be enhanced accordingly. From such a viewpoint, the current labor shortage not only leads to enhancing the growth potential of the prefecture’s economy as a whole in the long run, but also might provide an opportunity to tackle structural issues of the local economy such as the declining population and the outflow of young people. In Hiroshima Prefecture, there are efforts toward creating new demand not only in the field of manufacturing but also in tourism and other services industries. For example, in addition to two World Heritage sites, Hiroshima Prefecture has garnered both domestic and international attention as a result of the visit by the President of the United States in May 2016 and the first baseball Central League championship by Hiroshima Toyo Carp in 25 years. Thus, the number of tourists visiting the prefecture has increased considerably of late. Nevertheless, spending per visitor is below the national average, suggesting that the prefecture is not making full use of its opportunities. In order to address such a situation, Hiroshima Prefecture is working on strengthening support for tourism products and services aimed at promoting tours and extending visitors’ stay by providing subsidies to private business operators. In addition, Hiroshima Prefecture, together with the six neighboring prefectures, set up in spring last year the “Setouchi DMO” — a destination management/marketing organization to promote tourism in the wider region. Members include regional financial institutions that provide support from the funding side. I place great trust in the active cooperation among industry, government, and the financial sector toward boosting the tourism industry of the Setouchi region. The Bank will strive to contribute to these efforts toward the revitalization of the region through extensive information gathering and analyses by its Hiroshima Branch. In closing, let me express my sincere hopes for the further development of Hiroshima Prefecture’s economy and convey my best regards. Thank you. 8/8 BIS central bankers' speeches
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bank of japan
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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, Sapporo, 2 August 2017.
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August 2, 2017 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Sapporo 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. Business sentiment of manufacturing firms has been on an improving trend on a global basis, and the world trade volume has been recovering. In this situation, overseas economies have continued to grow at a moderate pace on the whole. As for the outlook, the growth rates of overseas economies are expected to increase moderately. According to the World Economic Outlook Update, released in July 2017 by the International Monetary Fund (IMF), the global growth rate is projected to increase from 3.2 percent in 2016 to 3.5 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 steadily, albeit at a moderate pace, 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 such as those regarding negotiations on the United Kingdom's exit from the European Union (EU) and with 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, partly due to the effects of authorities' measures to support economic activity. As for the outlook, the economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Emerging economies other than China and commodity-exporting economies have picked up on the whole. As for the outlook, their growth rates are likely to increase gradually, due mainly to the spread of the effects of steady growth in advanced economies and the effects of the economic stimulus measures. Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the U.S. economic policies and their impact on global financial markets, (2) developments in emerging and commodity-exporting economies, (3) negotiations on the United Kingdom's exit from the EU and their effects, (4) prospects regarding the European debt problem, including the financial sector, and (5) geopolitical risks. I hold the view that it is important to stay vigilant regarding these risk factors, especially now that the growth rates of overseas economies are rising. 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 is expanding moderately, with a virtuous cycle from income to spending operating. For the first time in about 11 years, real GDP registered positive growth for five consecutive quarters, through the January-March quarter of 2017; by component, demand both at home and abroad has increased and the economy has been growing at a pace slightly above its potential, which is estimated to be in the range of 0.5-1.0 percent.1 With regard to the outlook, Japan's economy is likely to continue its moderate expansion. Through fiscal 2018, 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 continue their moderate increasing trend as the growth rates of overseas economies increase moderately. In fiscal 2019, the economy is expected to continue expanding, supported by external demand, although the growth pace is projected to decelerate due to a slowdown in Under a specific methodology, Japan's potential growth rate is estimated to be in the range of 0.5-1.0 percent. 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. domestic demand.2 According to the July 2017 Outlook for Economic Activity and Prices (hereafter the Outlook Report), released by the Bank of Japan, the medians of the Policy Board members' forecasts of the economic growth rate are 1.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and 0.7 percent for fiscal 2019. 2. Prices Next, I will talk about price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.0-0.5 percent. The rate of increase for all items less fresh food and energy had remained on a decelerating trend, following the peak of 1.2 percent in winter 2015; recently, the rate of change has been at around 0 percent. With regard to the outlook, the year-on-year rate of change in the CPI for all items less fresh food is likely to continue on an uptrend mainly on the back of the improvement in the output gap and the rise in medium- to long-term inflation expectations. The rate will likely reach around 2 percent in around fiscal 2019. Specifically, the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI for all items less fresh food presented in the July 2017 Outlook Report are 1.1 percent for fiscal 2017, 1.5 percent for fiscal 2018, and, excluding the direct effects of the scheduled consumption tax hike, 1.8 percent for fiscal 2019.3 It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers. The consumption tax hike scheduled to take place in October 2019 -- to 10 percent -- and the reduced tax rate to be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers are incorporated in the forecasts, but individual Policy Board members make their forecasts of the CPI based on figures excluding the direct effects of the consumption tax hike. The forecasts for the CPI for fiscal 2019 that incorporate the direct effects of the consumption tax hike are constructed as follows. First, the contribution to prices from the tax hike is mechanically computed on the assumption that the tax increase will be fully passed on for taxable items. The CPI will be pushed up by 0.5 percentage point. Second, this figure is added to the forecasts made by the Policy Board members. 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 tighten steadily and employee income has increased moderately. The rate of increase in the number of employees has remained at around 1 percent. Against this backdrop, the active job openings-to-applicants ratio, which has followed a steady uptrend, has exceeded its highest figure during the bubble period in the first half of the 1990s, and a perception of labor shortage suggested by indicators related to employment has heightened. The unemployment rate has continued on a moderate declining trend, albeit with some fluctuations, and has been around 3 percent recently. It is expected that the number of employees will keep increasing and that the supply-demand conditions in the labor market will further tighten. On the wage side, the rise in hourly cash earnings has generally accelerated, albeit with fluctuations. Specifically, the year-on-year rate of increase in hourly cash earnings of part-time employees recently registered relatively high growth in the range of 2.0-2.5 percent. With regard to the outlook, the pace of increase in full-time employees' cash earnings is expected to accelerate moderately, with that in base pay accelerating as the rise in inflation expectations becomes more evident. In light of these prospects for employment and wages, employee income is expected to increase at a moderate pace, and its pace of increase is expected to be slightly above the nominal GDP growth rate in the second half of the projection period of fiscal 2016-2019. However, there is a risk that firms will remain cautious with their decisions, particularly on wage setting. In this context, I am paying attention to firms' wage-setting stance going forward. B. Private Consumption Next, I will discuss developments in private consumption, which has increased its resilience against the background of steady improvement in the employment and income situation. The consumption activity index has continued to increase. Looking at private consumption by type, durable goods have been on a moderate uptrend, mainly due to replacement demand for automobiles and household electrical appliances. Nondurable goods had seen somewhat weak developments for a prolonged period, particularly in clothes, but have started to pick up recently. Meanwhile, services consumption has continued to increase moderately, albeit with fluctuations, reflecting a trend rise in communications charges as well as medical, health care, and welfare fees. With regard to the outlook, private consumption is expected to follow a moderate increasing trend -- albeit with fluctuations due to the scheduled consumption tax hike -- supported mainly by an increase in employee income and replacement demand for durable goods. 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. Business fixed investment plans for fiscal 2017, especially those of large enterprises, show firms' solid stance. Specifically, on a year-on-year basis, firms' fixed investment increased by 0.4 percent in fiscal 2016, and investment plans for fiscal 2017 project an increase of 5.9 percent. As for the outlook, business fixed investment is likely to continue increasing moderately 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 the output gap and inflation expectations, which are the main factors that determine inflation rates. First, the output gap -- after turning slightly positive in the July-September quarter of 2016 -- has continued to improve, and it has expanded somewhat within positive territory recently. With regard to the outlook, it is projected to widen further within such territory in fiscal 2017; thereafter, it is projected to continue expanding moderately within positive territory both on the capital and labor sides, reflecting the increase in demand at home and abroad. In the second half of fiscal 2019, although such expansion is likely to pause due to the effects of the scheduled consumption tax hike, the output gap is expected to remain substantially positive. Second, medium- to long-term inflation expectations have remained in a weakening phase; however, some indicators show a rise in such expectations recently. As for the outlook, medium- to long-term inflation expectations are likely to follow an increasing trend on the back of the following: (1) in terms of the adaptive expectation formation mechanism, firms' stance is likely to gradually shift toward raising wages and prices with the improvement in the output gap, and (2) in terms of the forward-looking expectation formation mechanism, the Bank will pursue monetary easing through its strong commitment to achieving the price stability target. III. Conduct of Monetary Policy Let me now turn to the Bank's monetary policy. In January 2013, the Bank announced that it would aim 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, and in April of that year, it decided to introduce Quantitative and Qualitative Monetary Easing (QQE) as a necessary measure to underpin this commitment. The Bank took several measures thereafter, and in September 2016 it 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. 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, according to the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. 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, 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. In Japan, there is some argument that the Bank does not need to aim at 2 percent inflation. However, when adverse shocks hit the economy, it becomes necessary to lower real interest rates sufficiently to support the economy effectively. Therefore, it is important to aim at achieving the price stability target of 2 percent in order to secure sufficient room for a reduction in real interest rates by keeping the inflation rate stable at around 2 percent and anchoring inflation expectations at 2 percent. 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, this momentum is not yet sufficiently firm, and we are only halfway to achieving the price stability target. 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. The Bank aims to achieve price stability that is sustainable. I recognize that the inflation rate consistent with sustainable price stability will rise as efforts by a wide range of entities toward strengthening the 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 -- a main price index. To strengthen the competitiveness and growth potential of the economy, a structural reform that will lead to an increase in productivity is necessary. In implementing such a reform, from the viewpoint of the management of firms, it is important to adjust supply to the trend in demand. In an economy with a declining population, as is the case in Japan, demand is expected to decrease for many goods and services; therefore, it will be important to adequately adjust supply capacity; that is, employees and production capacity to meet such a decreasing trend. In Japan, there is room for enhancing productivity relative to international standards. Firms, regardless of whether they are in manufacturing or nonmanufacturing, are faced with an uneven distribution of employees and production capacity, as well as excessive inventories and discounts. It is necessary to adequately correct such uneven distribution and reduce excessiveness in all areas. In order to make progress with such a structural reform smoothly while easing the pain arising from the reform, a growth strategy that will foster new areas with growth potential is essential. That is, it is necessary to develop and provide goods and services that will explore new demand, and at the same time expand the channels for capturing demand in neighboring economies. Japan's economy has made progress toward this end for many years despite the severe situation for the management of firms, and has exhibited strong compatibility. It is expected to make continued progress in the future. Currently, financial conditions are highly accommodative and labor market conditions are tight. It is a good time to proceed with the structural reform and growth strategy, and we should not miss this chance. I consider that the private sector, which plays the main role in the economy, should take the initiative to enhance productivity and create demand in a more proactive manner. Financial institutions are expected to provide consulting services to their counterpart firms making these efforts. In particular, in rural areas, financial institutions, which are endowed with information, knowledge, and experience, not to mention personnel, are expected to take such initiative. Moreover, it is a highly difficult task to increase labor input in the current situation where labor shortages are becoming severe. However, given that the tightness in labor market conditions varies by industry, the current moderate tightness can be regarded as a chance to increase mobility in the labor market -- including inter-industry labor reallocation -- in wider areas. Each firm will need to retrain its management staff to enhance their ability and adjust their mindset. Also, measures should be taken to change the decision-making process and reduce operations that do not produce value-added, such as duplicated operations, as well as excessive services. Progress toward improving the operation process that will lead to utilization of the workforce of women and the elderly also should be made. In this regard, the Bank conducted a survey on firms' efforts toward promoting women's labor force participation by region and released the results as the annex to the Regional Economic Report in June 2017.4 According to this annex, women's labor participation is increasing in many regions and has led to improvement in business performance and productivity. Thank you for your attention. The annex to the Regional Economic Report is available only in Japanese.
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Speech by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ehime, 31 August 2017.
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Takako Masai: Economic activity, prices, and monetary policy in Japan Speech by Mr Takako Masai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ehime, 31 August 2017. * * * I. Developments in economic activity and prices I would like to start my speech with a look at developments in economic activity and prices. At the Monetary Policy Meeting held on July 19 and 20, 2017, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices through fiscal 2019. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas economies Let me first touch on developments in overseas economies. The Bank's assessment is that overseas economies have continued to grow at a moderate pace on the whole. In terms of the outlook, advanced economies are projected to continue growing steadily and a recovery in emerging economies is likely to take hold on the back of the steady growth in advanced economies and the effects of policy measures taken by emerging economies. A similar view was presented in the World Economic Outlook (WEO) Update released in July 2017 by the International Monetary Fund (IMF). Looking at developments by major region, the U.S. economy has continued to recover, 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 will likely follow a moderate recovery trend, while uncertainty -associated with political issues such as those regarding negotiations on the United Kingdom's exit from the European Union (EU) and with the European debt problem, including the financial sector -- is likely to be a burden on economic activity. The Chinese economy will likely continue to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Other emerging economies and commodity-exporting economies have picked up on the whole, reflecting in particular a pick-up in exports, a bottoming out of commodity prices, and the effects of these economies' stimulus measures. These economies are likely to increase gradually, due mainly to the spread of the effects of steady growth in advanced economies. B. Japan's economy and price developments 1. Current situation Now I would like to discuss developments in economic activity and prices in Japan. The Bank's assessment is that Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. In fiscal 2017 to date, the Bank has revised its economic 1/6 BIS central bankers' speeches assessment upward twice. These revisions are based on its judgment that a positive output gap has taken hold, as evidenced by the fact that industrial production has been on an increasing trend, reflecting the increases in demand both at home and abroad, and that labor market conditions have continued to tighten steadily. On the domestic demand side, business fixed investment has been on a moderate increasing trend, with corporate profits and business sentiment improving and across a wider range of industries. According to the June 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan), business plans for fiscal 2017, especially those of large enterprises, showed firms' solid stance. This is evidenced by, for example, the fact that fixed investment on a basis close to GDP definition saw a year-on-year increase of 5.9 percent -- a level clearly exceeding the past average of 4.3 percent for the June Tankan surveys during the period of fiscal 2004-2016. Private consumption has increased its resilience against the background of steady improvement in the employment and income situation, and housing investment has been more or less flat. Exports have been on an increasing trend against the backdrop of developments in overseas economies that I mentioned earlier. On the price front, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.0-0.5 percent. 2. Outlook I will now look at the outlook for Japan's economy during the projection period, which covers from fiscal 2017 through fiscal 2019. The economy is likely to continue its 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. Exports are expected to continue their moderate increasing trend along with the improvement in overseas economies. Reflecting this outlook, Japan's economy is likely to maintain growth at a pace above its potential mainly through fiscal 2018. In fiscal 2019, it is expected to continue expanding, although the growth pace is projected to decelerate due to a cyclical slowdown in business fixed investment and the effects of the scheduled consumption tax hike. Looking at the medians of the Policy Board members' forecasts in the July 2017 Outlook Report, the real GDP growth rate is projected to be 1.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and 0.7 percent for fiscal 2019. Let me explain the outlook in detail by major component. Business fixed investment is likely to continue increasing moderately. This is because, in a situation where extremely stimulative financial conditions are maintained, fixed investment will be positively affected by (1) high levels of corporate profits, (2) fiscal measures including projects conducted under the Fiscal Investment and Loan Program and tax reductions for capital investment, and (3) moderate improvement in growth expectations. Specifically, an increase is likely to be seen in investment, particularly (1) that related to the Olympic Games and urban redevelopment projects, (2) in efficiency-improving and labor-saving machinery and equipment in order to deal with labor shortages, and (3) in research and development for growth areas. Private consumption is expected to continue increasing moderately as the employment and income situation continues to improve, and housing investment is expected to remain more or less flat. Exports are likely to be firm as a trend for the time being, underpinned by those of capital goods and IT-related goods -- in which Japan has a comparative advantage. Thereafter, they are expected to continue their moderate increasing trend, due mainly to the improvement in overseas economies, albeit with a decline in IT-related demand following the current increase. Industrial production is projected to continue on a moderate increasing trend -- despite being affected by the cycle of global demand for IT-related goods -- as the recovery in emerging economies takes hold and the effects of the set of stimulus measures become evident. The year-on-year rate of change in the CPI (all items less fresh food) is likely to increase toward 2/6 BIS central bankers' speeches around 2 percent. This is because, although upward pressure of energy prices is likely to wane gradually, firms are likely to gradually shift their stance toward raising wages and prices with an improvement in the output gap, and inflation expectations are expected to accelerate moderately. Looking at the medians of the Policy Board members' forecasts in the July 2017 Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is projected to be 1.1 percent for fiscal 2017, 1.5 percent for fiscal 2018, and -- on a basis excluding the effects of the scheduled consumption tax hike -- 1.8 percent for fiscal 2019. II. The Bank's monetary policy Next, I will talk about the Bank's monetary policy. A. Quantitative and qualitative monetary easing (QQE) with yield curve control At the Monetary Policy Meeting held in September 2016, with a view to achieving the price stability target of 2 percent at the earliest possible time, the Bank decided to introduce QQE with Yield Curve Control as a means of strengthening the framework for monetary easing. This consists of two major components. The first is an "inflation-overshooting commitment" in which the Bank commits itself to continuing to expand the monetary base until the year-on-year rate of increase in the observed CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. Japan's economy has suffered from deflation for more than 15 years, since the late 1990s, with the yearon-year rate of change in the CPI being about zero or slightly negative. It seems that one of the reasons why it has been taking time for the deflationary mindset to be dispelled in Japan is that households and firms have been adaptive to the deflationary environment. Given this, I believe it is important that the Bank demonstrate its unwavering determination through such a commitment so that the perception that prices of goods and services are supposed to go up every year by around 2 percent becomes firmly entrenched among people. The second component is "yield curve control" in which the Bank controls short-term and longterm interest rates. In the current framework, it sets the short-term policy interest rate and the target level of the 10-year Japanese government bond (JGB) yields as its operating targets. At present, in the guideline for market operations, the Bank sets the short-term rate at minus 0.1 percent and the target level at around 0 percent, and conducts JGB purchases so as to achieve this target level. Almost a year has passed since the Bank introduced QQE with Yield Curve Control. Under this framework, the yield curve has been formed smoothly so far in a manner consistent with the guideline for market operations. Since the introduction of QQE in 2013, the basic transmission channel of monetary easing has been the reduction in real interest rates, and the current framework -- QQE with Yield Curve Control -- is designed to amplify monetary easing effects when the outlook for economic activity and prices improves. In that case, there would be upward pressure on interest rates in accordance with such improvement. The degree of monetary easing will increase if the Bank contains such upward pressure and thereby maintains the shape of the yield curve. B. Toward achieving the price stability target The Bank projects that the timing of the year-on-year rate of change in the CPI reaching about 2 percent will be around fiscal 2019. In the Outlook Report, the Bank has delayed such timing several times, and I acknowledge that there is some criticism on this point. The Bank certainly aims to achieve the price stability target of 2 percent at the earliest possible time, and the delay in such timing is not desirable. However, what I believe is important for the Bank is -- in the event that the 2 percent price stability target cannot be achieved due to economic and price developments at the time -- to thoroughly explain the reasons behind the target not being achieved and to implement monetary policy so that the economy will follow a path toward the 3/6 BIS central bankers' speeches target. After all, it is well known that the policy framework of inflation targeting is expected to perform the role of a communication tool. As I mentioned earlier, the year-on-year rate of change in the CPI is in the range of 0.0-0.5 percent, meaning that there is still a long way to go to achieve the price stability target of 2 percent. Nevertheless, my view is that the momentum toward achieving the target has started to steadily increase. In this regard, let me highlight two points. First, although it has been said that wages have not been increasing as expected, scheduled cash earnings have continued to rise for more than two years. Let me also note that, as scheduled cash earnings have been rising steadily at small firms, where the majority of workers are employed, a clearly increasing number of households can now feel that their wages actually have been rising. This is highly important in terms of raising people's inflation expectations. The second point is that there clearly has been a growing impetus toward raising productivity, due in part to labor shortages. As I noted earlier, investment that serves a positive purpose -such as that in efficiency-improving and labor-saving machinery and equipment, and in research and development for growth areas -- is expected to further rise, and this will likely contribute to improving productivity. Moreover, it has become easier for firms to take advantage of such new information technologies as artificial intelligence (AI) and the Internet of Things (IoT). Let me also mention that the government's latest growth strategy, the Investments for the Future Strategy 2017 -- which was decided by the Cabinet in June 2017 -- emphasizes the importance of promoting comprehensive policies with the aim of improving productivity in the economic society. In addition to such policy measures being steadily pursued by the government, the Bank's initiatives to maintain highly accommodative financial conditions and ensure the overcoming of deflation will continue to foster positive developments among firms. In my view, this will lead to improvement in productivity and ultimately to a rise in the potential growth rate. The initiatives of the public and private sectors, such as those just mentioned, have been carried out in a remarkably wide range of fields. The promotion of women's participation in the economy -- the next topic I will touch upon -- is one example. III. Women's participation in the economy and increase in Japan's growth potential In April 2016, the Act on Promotion of Women's Participation and Advancement in the Workplace was fully enforced. Since then, it has become a mandate for business entities to formulate and make public their action plans that incorporate numerical goals toward promoting women's participation in the workplace, and to disclose information on women's job choices. While the Act has been enacted as a temporary legislation with a 10-year term limit, it aims at actively providing women with opportunities for employment and promotion. In that sense, it clearly differs from past ones for which the key element was a ban on gender discrimination. Let me note that business entities that are mandated to disclose information in accordance with the Act include government agencies, local governments, and large private-sector corporations. The Bank also has disclosed information in accordance with the Act, and in May 2017, it gained the highest level of the "Eruboshi" award -- a certification from the Ministry of Health, Labour, and Welfare for excellent implementation of initiatives toward promoting women's participation and advancement in the workplace. With the full enforcement of the Act, Japan has entered a new stage of women's participation in the economy. Such participation is placed at the center of the government's Japan Revitalization Strategy, and is essential in terms of increasing the growth potential. A. Women's participation expected to increase labor supply The labor force participation rate of women by age group in Japan has been known to form an Mshaped curve, where the rate temporarily dips for the age group in which many women 4/6 BIS central bankers' speeches experience childbirth and provide childcare. Recently, however, women in this age group seem to be increasingly participating in the labor force, and the temporary dip in the rate clearly has moderated. Looking at the breakdown of the number of workers by gender over the past five years, that for women has been increasing -- despite the decline in the overall working-age population -- and therefore it can be assessed that women's participation in the labor force has been progressing smoothly. Furthermore, such developments have been spreading across Japan. I should note that the estimated number of women who wish to work still stands at about 2.74 million, which shows that women continue to constitute a considerably large potential labor force. Japan's economy currently faces severe labor shortages, and a worsening of this situation is inevitable amid the further decline in the working-age population. The Organisation for Economic Co-operation and Development (OECD) estimates that, if women's labor participation rate in Japan were to remain the same over the next 20 years, the labor supply would contract by 17 percent; meanwhile, if women's participation rate were to converge with that of men over the next 20 years, the fall in labor supply would be limited to 5 percent. As a result, GDP would increase by almost 20 percent over the two decades.1 B. Expectations for improving firms' competitiveness In addition to the impact on labor supply of women's participation in the workplace, improving firms' competitiveness through the promotion of such participation will become more important. In the annex to the Regional Economic Report released in June 2017, the Bank introduced some recent initiatives taken by firms to raise productivity through the following two innovations associated with the promotion of women's participation in the workplace.2 First was an initiative -- through product innovation -- that created potential demand by making use of women's viewpoint and sensibility in developing and providing new products and services. The annex presented examples of a case in which firms succeeded in discovering demand that led to boosting their corporate performance, such as the following: a hotel that had commonly been used for business trips conducted a renovation of guest rooms and a renewal of amenity goods by adopting suggestions from women employees, and this led to acquiring female tourists. I think that having such a successful experience even once will enable firms to take a more positive stance toward going through the trials and errors of reforming their business models. Second was an initiative -- through process innovation -- that consequently led to improvement in business efficiency as a result of measures implemented in the process of promoting women's participation in the workplace, such as redressing of long working hours and labor-saving investment. It may seem that redressing of long working hours spurs labor shortages. However, the annex in fact presented an example of efforts made by firms in which they eliminated tasks that fell short of being necessary, as a result of the fact that working hours were forcibly shortened and there was no choice but to reduce the amount of work. C. Opportunity to increase the economic growth potential I would like to highlight again that, at present, not only are firms facing the challenge of labor shortages, but they also have more opportunity to take advantage of such information technologies as AI and the IoT. In other words, there is an environment in which firms are encouraged to reform their business models. One option for firms at this time is to aim at starting a business revolution by using women's participation and advancement in the workplace as a driving force, as this momentum is increasing, due in part to the government's support that I mentioned earlier. 1 The OECD estimates the effects of women’s labor force participation rate on labor supply under the two scenarios based on the following assumptions: (1) the labor force participation rates for both men and women remain constant from 2011 to 2030 at the rates observed in 2010, and (2) the labor force participation rate for 5/6 BIS central bankers' speeches men stays the same from 2011 to 2030 at the rate observed in 2010 while that for women gradually increases from 2011 to 2030, reaching the 2010 rate for men by 2030. For details, see OECD (2014), Japan: Advancing the Third Arrow for a Resilient Economy and Inclusive Growth, OECD Publishing, Paris. dx.doi.org/10.1787/9789264215955-en. 2 The annex to the Regional Economic Report is available only in Japanese. 6/6 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, 25 September 2017.
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September 25, 2017 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka 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 a distinguished gathering of business leaders in the Kansai region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the various activities of the Bank of Japan's branches in Osaka, Kobe, and Kyoto. In my speech today, I would like to first explain the Bank's view on the recent developments in economic activity and prices, and then talk about its thinking behind the conduct of monetary policy. I. Economic Developments Let me start by talking about developments in Japan's economy. The economy is expanding moderately, and the real GDP growth rate for the April-June quarter registered a firm increase of 2.5 percent on an annualized basis. It is the first time in eleven years, since 2006, that it has continued to mark positive growth for six consecutive quarters (Chart 1). Looking ahead, the economy is likely to continue its moderate expansion. Some of the recent characteristics of the economic expansion are as follows. The first feature is that the economic growth has been led by both external and domestic demand in a well-balanced manner. Looking at overseas economies, business sentiment in the manufacturing sector has been on an improving trend in both the advanced and the emerging economies, and the world trade volume has been recovering. Under such circumstances, Japan's exports have been on an increasing trend, such as those of automobile-related and capital goods (Chart 2). Regarding domestic demand, business fixed investment has been on a moderate increasing trend as corporate profits have been at record high levels. Private consumption has increased its resilience recently against the background of steady improvement in the employment and income situation. Furthermore, as the effects of the government's large-scale stimulus measures formulated last year have been emerging lately, public investment has been increasing (Chart 3). The economy has been expanding, not on the basis of a single factor, but rather supported by multiple factors -- namely, external demand, domestic private demand, and domestic public demand -- in a well-balanced manner. For this reason, the economic expansion can be expected to sustain itself going forward. The second feature of the recent economic expansion is that its effects have been spreading to a wide range of economic entities. The differences in the degree of improvement in the diffusion index (DI) for business conditions either by firm size or by region are not as large as those during the recovery phase in the mid-2000s before the global financial crisis (Chart 4). The DI for the Kinki region had been below the national average from 2015 toward 2016, but has been improving rapidly since the second half of 2016, reflecting a remarkable recovery in overseas economies. Looking at the employment and income situation, the current economic expansion has benefitted a wide range of households. The year-on-year rate of increase in hourly wages of part-time employees, which are particularly sensitive to the tightening of the labor market, has registered about 2.5 percent. This is higher than that of full-time employees, implying that the difference in wage levels between part-time and full-time employees has become smaller. There have been many cases where those who had worked as part-timers but wanted to become employed as full-timers have been able to do so. Moreover, the active job openings-to-applicants ratio of full-time employees exceeded 1 in June for the first time since the statistics started to be compiled in 2004 (Chart 5). As just described, the economic expansion has been benefitting both full-time and part-time employees. In the labor market as a whole, the unemployment rate has declined to around 3 percent, which is equivalent to virtually full employment, and the active job openings-to-applicants ratio stands at 1.52, exceeding the highest figure during the bubble period and reaching a level last seen as far back as in 1974 (Chart 6). Triggered in part by the tightening of labor market conditions, it has become another feature of Japan's economy of late that a wide range of firms and industries have been taking measures to raise labor productivity. Since wage increases resulting from labor shortage mean rises in labor costs for firms, many firms have been making various efforts to avoid passing on a rise in labor costs directly to their customers. A typical example is labor-saving and efficiency-improving investment with the use of information technology. In fact, in labor-intensive sectors such as retailing as well as accommodations, eating and drinking services, software investment has increased to a remarkable degree recently (Chart 7). Furthermore, firms have been streamlining their business processes. For instance, some supermarkets and chain restaurants have discontinued services late at night and early in the morning, at which time the number of customers is relatively small, and instead allocated their limited employees to daytime services. Even with reduced labor input due to shorter business hours, sales will not decrease so much, thereby lifting firms' labor productivity. Of these measures, increasing labor-saving and efficiency-improving investment has certainly contributed to the recent growth in business fixed investment. In addition, from a longer-term perspective, firms' various efforts are expected to play an important role in raising Japan's growth potential. In Japan, it is essential to raise labor productivity to compensate for the decline in labor force. Although this is not easy, firms' increasing efforts of various kinds amid the widespread labor shortage of late have become a driving force toward raising productivity, which is a long-standing challenge to Japan's economy. II. Price Developments Now I will move to price developments. The year-on-year rate of change in the consumer price index (CPI) excluding fresh food has increased to around 0.5 percent recently, but that which also excludes the effects of a rise in energy prices has been relatively weak, remaining at around 0 percent (Chart 8). Looking ahead, the Bank of Japan projects that the rate of change in the CPI is likely to continue on an uptrend and increase toward 2 percent. In what follows, let me describe how this process will operate, especially from firms' standpoint. What lies behind the fact that inflation has been relatively weak despite the increase in labor costs is firms' efforts to absorb the costs that I mentioned earlier. Specifically, many Japanese firms have raised wages for their employees but kept the prices of products and services unchanged, through labor-saving investment and streamlining of their business processes, for example. It often is pointed out that one reason why firms do not raise their sales prices is a kind of caution that, if they raise their prices but competitors do not, they may lose customers and competitiveness in the market. Given that their competitors have the same thought, perhaps all the competing firms wait and see what others will do and none make the first move. This strategy itself would be reasonable for firms facing stiff competition. At the same time, however, it also makes it unlikely that firms will raise their sales prices by passing on increased costs to those prices as necessary. What will happen going forward? Given that firms have already been working on streamlining their business processes in many ways, it will gradually become difficult for them to continue to absorb increases in wage costs through those measures. In addition to continuing efforts to streamline their business processes, firms will need to reflect in their sales prices the increased costs that they cannot absorb. Lately, it also seems to be becoming more likely that competitors will follow suit when a firm moves toward increasing its prices. This is because it is highly likely that, facing a tight labor market, every firm feels that it has been reaching the limit to which it can absorb increasing labor costs. On the consumer side, their perception of price rises seems to be changing gradually, as the employment and income situation has improved due to the better labor market conditions. After one of the major transportation companies announced this spring that it planned to raise the prices of its delivery services, competitors followed suit. According to a news report, slightly more than 30 percent of firms in the restaurant business are planning to raise the prices on their menus within this fiscal year, mainly due to increases in labor costs. These developments appear to show the possibility that firms' price-setting stance has been changing in response to the tightening of the labor market and improvement in the economy. These kinds of changes in firms' price-setting stance have not yet become widespread in the entire economy. However, as firms' and consumers' stance on the passing on of costs changes with the economy continuing to expand moderately, firms' attempts to raise sales prices will likely gradually become more widespread across a broad range of industries. Furthermore, as this process lifts actual prices, firms' and households' medium- to long-term inflation expectations, or people's perception of future inflation, will increase. The Bank of Japan projects that, through these mechanisms, the inflation rate is likely to increase gradually toward the price stability target of 2 percent. III. The Bank's Conduct of Monetary Policy Next, I will elaborate on the Bank's thinking behind the conduct of monetary policy. As stipulated in the Bank of Japan Act, the objective of the Bank's monetary policy is "achieving price stability, thereby contributing to the sound development of the national economy." The specific number representing "price stability" is "2 percent" in terms of the year-on-year rate of change in the CPI. For reasons why this needs to be 2 percent, I will explain three points in sequence: a bias in price statistics, securing policy room for the future, and a global standard. Let me start with a bias in price statistics. Although I am not going into detail since this might be a bit technical, the inflation rate based on the CPI that the Bank refers to tends to be higher than actual inflation. Given this, aiming at zero inflation in terms of the CPI means aiming at negative inflation, in effect. Therefore, in order to ensure price stability, the inflation rate should be sufficiently positive. The next point regards securing policy room for the future. The level of nominal interest rates is usually determined in accordance with that of inflation rates. Looking at the interest rate levels around 2007, right before the global financial crisis, whereas the policy interest rates in the United States and Europe were around 4 to 5 percent with inflation of around 2 percent, the policy interest rate in Japan, or the uncollateralized overnight call rate, was only 0.5 percent with almost zero inflation (Chart 9). In response to the global financial crisis, which exerted a significantly negative impact on the global economy, the United States and Europe counteracted this shock with monetary easing that pushed down the policy interest rates by 4 to 5 percentage points to around 0 percent. On that occasion, although Japan also reduced the policy interest rate to around 0 percent, as the United States and Europe did, it was only able to exert limited monetary easing effects of 0.5 percentage point. As you remember, the real GDP in Japan dropped more significantly than that in Europe and in the United States, the epicenter of the crisis. This implies the possibility that the fact that Japan had less room for policy responses in lowering interest rates became a contributing factor to the severer downturn of the economy. With the level of nominal interest rates being high, Japan's economy will have more policy room to mitigate the impact of future economic downturns, or will be equipped with a sort of insurance for sustained economic growth. So far, I have mentioned a bias in price statistics and securing policy room for the future, but these alone do not give a good enough reason why the target level of inflation has to be 2 percent. There are some proposals advocated overseas that the target level of inflation should be 3 to 4 percent in order to further increase policy room, although these proposals themselves do not seem realistic. So, why is 2 percent considered most appropriate? To answer this question, the third reason, a global standard, is key. Central banks in major economies are currently conducting monetary policy with the aim of achieving around 2 percent inflation. Given this, the Bank of Japan's monetary policy conduct with the aim of achieving 2 percent inflation is also likely to contribute to stable foreign exchange rates in the long run. Foreign exchange rates fluctuate due to various factors in the short run, but they are considered to reflect inflation differentials between at home and abroad in the long run. From the long-run perspective, if the inflation rate at home remains stable at around the same level as those in other major economies, stability in foreign exchange rates consequently will be ensured. For the preceding three reasons, the Bank sets the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. However, some may feel uncomfortable about aiming at a positive inflation rate of 2 percent. For example, in the Bank's Opinion Survey on the General Public's Views and Behavior, a questionnaire survey of individuals, about 80 percent of respondents answered that price rises are rather unfavorable. I would like to emphasize that what the Bank aims at in the conduct of monetary policy is not simply an increase in inflation. It aims to achieve an economy with a virtuous cycle in which the incomes of people increase firmly as the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI is achieved. The historical data show that consumer prices and wages have generally been moving in parallel. In Japan in the 1980s and in the United States, with positive inflation, nominal wages generally increased at a higher pace than the CPI (Chart 10). Given that developments in actual prices are factored in at annual spring labor-management wage negotiations, the parallel relationship between inflation and wage growth is easy to understand. In such an economic environment, nominal interest rates usually will increase as well. Since interest rates are the rates of return on investment for each economic activity within the economy as a whole, they are expected to converge to the level consistent with the nominal growth rate of the country in the medium to long run. In an economy with economic expansion and steady positive inflation, both nominal wages and nominal interest rates increase, which means that the incomes of wage and salary earners, and of those who are living off their deposits, will increase. I would like to underscore the fact that the Bank, through achieving the price stability target of 2 percent, is aiming at realizing a well-balanced economy in which people's incomes increase accordingly. Conclusion Lastly, I would like to conclude my speech by briefly explaining the Bank's recent conduct of monetary policy. The Bank has been implementing powerful monetary easing under "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control," aiming to achieve the price stability target of 2 percent. This policy framework was introduced exactly a year ago, and at this meeting with you last year, I talked about the new policy, which had just been introduced. "QQE with Yield Curve Control" consists of two components. The first 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 actual CPI exceeds 2 percent and stays above that level in a stable manner. The second component is yield curve control, in which the Bank controls short- and long-term interest rates under the guideline for market operations decided at every Monetary Policy Meeting. Looking back at the one year since its introduction, Japan's long-term interest rate has been stable at around zero percent, which is the target level, and bank lending rates as well as issuance rates for corporate bonds have been at extremely low levels. Moreover, financial institutions' lending attitudes as perceived by firms have remained positive both for large and small firms, and the year-on-year rate of increase in the amount outstanding of bank lending has been in the range of 3.0-3.5 percent recently. Such highly accommodative financial conditions, as well as proactive initiatives by financial institutions, have been firmly supporting corporate activities in Japan. Although there is still a long way to go to achieve the price stability target of 2 percent, the Bank will continue to persistently pursue powerful monetary easing with a view to achieving the target at the earliest possible time. Thank you. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka September 25, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Real GDP ann., tril. yen Real GDP (level, s.a.) CY06 Source: Cabinet Office. Chart 2 External Demand Exports Global Manufacturing PMI s.a., DI Global economy Advanced economies Emerging and commodity-exporting economies s.a., CY 2015=100 Real exports CY10 CY10 Notes: 1. Figures in the left chart for the global economy are the "J.P. Morgan Global Manufacturing PMI." Figures for advanced economies as well as emerging and commodity-exporting economies are calculated as the weighted averages of the Manufacturing PMI using PPP-adjusted GDP shares of 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 16 countries and regions, such as China, South Korea, Taiwan, Russia, and Brazil. 2. Figures for real exports are based on BOJ staff calculations. The figure for 2017/Q3 is the July-August average. Sources: IHS Markit (© and database right IHS Markit Ltd 2017. All rights reserved.); Bank of Japan; Ministry of Finance, etc. Chart 3 Domestic Demand Corporate Profits and Business Fixed Investment s.a. , % s.a., tril. yen Ratio of current profits to sales (all industries and enterprises, left scale) Private non-residential investment (SNA, real, right scale) Private Consumption 95 108 90 106 s.a., CY 2010=100 Public Investment Consumption Activity Index (travel balance adjusted, real) s.a., tril. yen s.a., tril. yen Public construction completed (nominal, left scale) Public investment (real, right scale) CY06 07 08 09 10 11 12 13 14 15 16 17 CY01 03 05 07 09 11 13 15 17 CY06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. Figures for corporate profits are based on the "Financial Statements Statistics of Corporations by Industry, Quarterly." Excluding "finance and insurance." 2. Figures for private consumption are based on BOJ staff calculations (as of September 7). Figures exclude inbound tourism consumption and include outbound tourism consumption. The figure for 2017/Q3 is that for July. 3. The figure for public construction completed for 2017/Q3 is that for July. 4. Figures for private non-residential investment, public construction completed and public investment are annualized. Sources: Ministry of Finance; Cabinet Office; Bank of Japan; Ministry of Land, Infrastructure, Transport and Tourism. Chart 4 Business Conditions DI (Tankan) By Region By Firm Size DI ("favorable" - "unfavorable"), % points DI ("favorable" - "unfavorable"), % points "Favorable" "Favorable" "Unfavorable" "Unfavorable" -10 -10 -20 -20 -30 -30 Range of responses by region -40 Kinki region -50 Japan (all industries and enterprises) Large enterprises -40 Medium-sized enterprises -50 Small enterprises -60 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 -60 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Source: Bank of Japan. Chart 5 Employment and Income Situation Active Job Openings-to-Applicants Ratio of Full-time Employees Hourly Cash Earnings y/y % chg. Hourly cash earnings Hourly scheduled cash earnings (part-time employees) 1.1 s.a., ratio 1.0 0.9 0.8 0.7 0.6 0.5 -2 0.4 0.3 -4 0.2 CY 06 Note: For hourly cash earnings, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures for 2017/Q3 are those for June-July averages. Source: Ministry of Health, Labour and Welfare. Chart 6 Employment and Income Situation Active Job Openings-toApplicants Ratio Unemployment Rate s.a., % 1.6 s.a., ratio 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 CY 06 0.3 CY 06 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 7 Software Investment FY 2005＝100 All industries Construction Retailing Accommodations, eating & drinking services FY 05 Note: Figures up through fiscal 2016 are actual results, and figures for fiscal 2017 are forecasts from the June 2017 survey (Tankan). Source: Bank of Japan. Chart 8 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: The CPI figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 9 Monetary Policy Responses and Developments in Real GDP after the Global Financial Crisis Real GDP Policy Interest Rates % s.a., 2008/Q2=100 Japan United States Euro area United Kingdom Japan -1 CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 United States Euro area United Kingdom CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Note: For Japan, for the period when no target interest rate was adopted, figures for the policy rate are the interest rate applied on excess reserves. Sources: Bank of Japan; Federal Reserve; European Central Bank; Bank of England; Cabinet Office; Haver. Chart 10 Prices, Nominal Wages, and Nominal Interest Rates United States Japan % % Consumer prices Consumer prices Nominal wages (hourly earnings) Nominal wages (hourly earnings) Nominal interest rates Nominal interest rates -2 -2 1980s 1990s 2000s 2010s 1980s 1990s 2000s 2010s Notes: 1. Figures for the 2010s are 2010-2016 averages. Figures for consumer prices and nominal wages are the averages of the year-on-year rates of change. Notes: 2. Figures for consumer prices are the CPI (all items, adjusted for changes in the consumption tax rate) for Japan and the PCE deflator (all items) for the United States. Notes: 3. Figures for nominal wages for the United States are "average hourly earnings of production and nonsupervisory employees: total private." Notes: 4. Figures for nominal interest rates include those for policy interest rates. Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bank of Japan; BEA; BLS; Bloomberg.
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Central Banking Seminar, hosted by the Federal Reserve Bank of New York, New York City, 18 October 2017.
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Hiroshi Nakaso: Evolving monetary policy - the Bank of Japan's experience Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Central Banking Seminar, hosted by the Federal Reserve Bank of New York, New York City, 18 October 2017. * * * Introduction This year marks an important milestone. Nine years have passed since the collapse of Lehman Brothers in 2008, which was one of the most visible flashpoints of the global financial crisis, and ten years have passed since what should be considered as its foreshock — the emergence of the subprime mortgage problem in 2007. The global financial crisis, which brought about severe disruptions in the global financial markets and a significant downturn in the global economy, has had various impacts on the global economy to date, including the European debt problem in the 2010s. During the decade, central banks around the globe have been facing many challenges. In addressing these challenges, central banks not only conducted conventional monetary policy such as reduction of short-term policy interest rates, but also devised and proactively adopted new policy measures called unconventional monetary policy. This reflects the fact that the monetary policy framework of each central bank has evolved in accordance with their respective economic conditions, in order to overcome the zero lower bound on short-term interest rates. At the same time, however, central banks’ initiatives have a lot in common, and there are many cases where similar policies have been adopted. Such similarities in the evolution of monetary policy are largely affected by the fact that the economies have been facing the same policy challenges during the same period in the wake of the global financial crisis, which brought about a significant shock on a worldwide scale. However, what seems more important is that central banks in the meantime have been strengthening their ties and establishing a relationship that has allowed them to learn from each other, which I think has served as the driving force for many of their monetary policies to evolve in the same direction during this period. In my speech today, I would like to express my views on the evolution of monetary policy, while looking back at the Bank of Japan’s experience to date, and then talk about the importance of cooperation among central banks. As some of you may not be familiar with Japan’s economy and the Bank of Japan’s monetary policy conduct, I have provided for your reference a chart entitled “Japan’s Economy and BOJ’s Monetary Policy” that shows major events for Japan’s economy and monetary policy since 1985. Please refer to it as needed. I. Japan’s monetary policy before the global financial crisis The challenge faced by central banks worldwide in conducting their monetary policy since the global financial crisis can be expressed in one phrase as “how to overcome the zero lower bound.” Before the crisis, the zero lower bound was discussed among academics but was not widely recognized as an actual serious policy challenge. However, Japan was in an exceptional situation. Let us turn back the clock to the 1990s. At this time, Japan’s potential growth rate had already started to decline, due mainly to the adverse effects of the burst of the bubble economy and the aging population (Chart 1). The potential growth rate, which had been around 4 percent in the early 1990s, declined to around 1 percent at the end of the 1990s. Along with this, the natural rate of interest, which is the real interest rate neutral to economic activity, also declined. Needless to say, the basic mechanism of monetary easing consists of driving the real interest rate below the natural rate of interest, thereby stimulating economic activity. Amid a decline in the natural rate of interest, the Bank reduced the policy interest rate incrementally, in pursuit of monetary easing effects. This is how we came to introduce the zero interest rate policy in 1999 (Chart 2). Specifically, the Bank decided in 1 / 15 BIS central bankers' speeches February 1999 to encourage the uncollateralized overnight call rate to move “as low as possible,” which means at virtually zero percent, by providing the market with more funds than necessary for financial institutions to meet their reserve requirements. In addition, it explicitly committed to continuing with the zero interest rate policy “until deflationary concern is dispelled.” While the impact of that policy was called the policy duration effect at the time, the policy is based on the same idea as what later was to be called forward guidance, in that it enhances monetary easing effects by guiding the future policy path. 2 / 15 BIS central bankers' speeches Thereafter, judging that Japan’s economy was showing clear signs of recovery, the Bank lifted the zero interest rate policy in 2000. However, toward the end of that year, the economy started to decelerate again, mainly because of the effects of the burst of the dot-com bubble in the United States. In response to this, the Bank in March 2001 introduced the quantitative easing policy, which set the outstanding balance of current accounts at the Bank as the operating target (Chart 3). This policy was unique, in that it focused on the current accounts, which are on the liability side of the central bank’s balance sheet. However, it paved the way for the introduction of large-scale asset purchases in many economies as well as quantitative and qualitative monetary easing (QQE) in Japan, which I will explain later, as it set not interest rates but quantity as the operating target. In addition, under the quantitative easing policy, the Bank committed to continuing the policy “until the annual rate of change in the consumer price index (CPI) registers zero percent or above in a stable manner.” This new commitment was an evolution of the previous version of the commitment that had been adopted alongside the zero interest rate policy, as it linked the condition of that commitment to the observed CPI and thereby aimed at gaining more powerful monetary easing effects. 3 / 15 BIS central bankers' speeches Looking back, the policy approaches at that time are applicable to the current environment, and I suppose you may not have much doubt about that. Yet, at that time, it was rather difficult to make the objectives and effects of these policies well understood. As I recall, they were considered as unique prescriptions for a certain economy, like Japan, with little implications for other economies. In fact, as we were a frontrunner of such monetary policy, we had no reliable precedents or textbooks — it was like navigating uncharted waters. I am aware that whether the policy had produced the effects as intended is open to debate. However, I take some pride in the fact that, in the face of severe economic and price developments, our strong sense of responsibility as a policy authority led to the development of new policy instruments, and that this in turn significantly affected monetary policy making around the globe in later years, both in terms of theory and practice. II. Evolution of monetary policy since the global financial crisis Let us now set the clock forward to 2008. Suffering a severe economic downturn triggered by the collapse of Lehman Brothers that year, central banks in major economies successively embarked on the introduction of unconventional monetary policies. At the outset, the Bank of Japan’s policies, such as the zero interest rate policy and the quantitative easing policy, drew attention and often were referred to by other economies. However, as the economic downturn persisted in many economies, central banks started to accumulate their own experiences, which then allowed them to learn from each other. In the course of this process, various attempts were made to overcome the zero lower bound, accelerating the evolution of monetary policy. The direction of this evolution can be broadly described by the following four approaches. The first is shifting the operating target to longer-term interest rates. With the zero lower bound on short-term interest rates, this measure aims to pursue a decline in real interest rates by setting the longer-term interest rates, for which room remains for a further reduction, as the target for monetary policy. As the longer-term interest rates are essentially the average of the 4 / 15 BIS central bankers' speeches future path of short-term interest rates plus the term premium, there are two possible ways of reducing these rates. One is to compress the term premium through longer-term lending and the purchases of government bonds by a central bank, and the other is to affect long-term interest rates by making commitments to the future path of short-term interest rates and maintaining them at lower levels. The latter is called forward guidance, which I mentioned earlier. In tackling the global financial crisis, the Federal Reserve and the European Central Bank (ECB) worked to enhance the influence on longer-term interest rates through a combination of several methods such as large-scale asset purchases and the introduction of forward guidance on short-term interest rates. The second approach is influencing risk premiums mainly through purchases of risk assets, amid a situation of less room to reduce interest rates on risk-free assets including government bonds. This measure, referred to as qualitative easing in Japan and credit easing in the United States, aims to further reduce firms’ and households’ funding costs by facilitating declines in risk premiums of such assets as corporate bonds, CP, and equities. It also is an attempt to break the limit to monetary easing effects resulting from the zero lower bound. The third approach is removing the zero lower bound by applying a negative short-term nominal interest rate. A central bank in Scandinavia for the first time after the global financial crisis developed a method to apply a negative interest rate to the central bank’s accounts held by private financial institutions. Some central banks including the Bank of Japan introduced this thereafter, while making their own modifications as appropriate. As is often pointed out, interest rates cannot be reduced to arbitrarily negative levels, given the presence of banknotes in circulation. In addition, we also need to take into account various costs and risks, including the impact on financial institutions’ profits. However, I think it is of notable significance that the longheld belief that nominal interest rates cannot be negative was overturned, and that the idea evolved into an actual policy option. The fourth approach is reducing real interest rates by influencing people’s inflation expectations, instead of by cutting nominal interest rates. In the case of Japan in particular, where deflation has persisted and the deflationary mindset has become entrenched among people, it is necessary to re-anchor medium- to long-term inflation expectations by exerting influence on people’s expectations. This will require the central bank’s strong commitment to achieving the inflation target, clear and consistent communication to the public, and determined actions to realize the commitment. Let me now explain the Bank of Japan’s monetary policy after the global financial crisis, while bearing in mind the four measures composing the evolution of monetary policy to overcome the zero lower bound that I just mentioned (Chart 4). In response to the collapse of Lehman Brothers in 2008, the Bank immediately reduced short-term policy interest rates, as did other central banks. As the pace of economic improvement remained sluggish, the Bank in October 2010 decided to introduce the comprehensive monetary easing policy. Specifically, it reduced the target level of short-term interest rates to 0 to 0.1 percent and committed itself to maintaining the virtually zero interest rate level “until it judges that price stability is in sight.” In addition, it established the Asset Purchase Program, through which it provided longer-term funds at a fixed rate and purchased various financial assets such as Japanese government bonds (JGBs), corporate bonds, and exchange-traded funds (ETFs). As these measures show, in order to overcome the zero lower bound, the Bank affected longer-term interest rates through JGB purchases and forward guidance, and started to compress risk premiums through purchases of corporate bonds and ETFs. In terms of the four approaches that I explained earlier, the Bank adopted the first two. 5 / 15 BIS central bankers' speeches Although the Bank continued to provide accommodative financial conditions through measures such as an expansion of the Asset Purchase Program and strengthening of forward guidance, this did not result in a significant improvement in economic activity and prices. Thus, the Bank newly introduced an extremely powerful policy package in April 2013 — namely, QQE. Under this framework, the Bank shifted the main operating target from interest rates to the monetary base, and incorporated all of the four approaches that I outlined earlier. First, it encouraged a decline in long-term interest rates more powerfully than before through large-scale JGB purchases of which the amount far exceeded that under the comprehensive monetary easing policy. Second, the purchase amount of assets, such as ETFs, was expanded substantially, thereby significantly strengthening the effects on risk premiums. Third, while this was introduced at a later date, in January 2016, with reference to measures taken by central banks in Europe, the zero lower bound itself was removed and a negative interest rate of minus 0.1 percent was applied to a portion of the Bank’s current account balances. Fourth, the Bank aimed to drastically change people’s expectations and thereby increase inflation expectations, by making a strong and clear commitment to achieving the price stability target of 2 percent. This commitment also was underpinned by the change in the main operating target to the monetary base and the announcement of its large-scale expansion. QQE has produced remarkable effects. Through the large-scale purchases of 10-year JGBs and a rise in inflation expectations, the Bank has succeeded in reducing real interest rates to levels well below the natural rate of interest for the first time in its two-decade-long battle with the zero lower bound on the short-term policy interest rate (Chart 5). As a result, Japan’s economy has improved significantly over the past four and a half years (Chart 6). As the output gap improved steadily, corporate profits have been at historically high levels and the labor market is very tight, at virtually full employment. Wages have increased steadily, albeit at a moderate pace. On the price front, the year-on-year rate of change in the CPI excluding fresh food and energy has been positive as a trend for about four years. This is the first time since the end of the 1990s that such positive developments are being observed in Japan. We judge that the economy is no longer in deflation, which is generally defined as a sustained decline in prices. 6 / 15 BIS central bankers' speeches 7 / 15 BIS central bankers' speeches III. Further evolution of monetary policy: QQE with yield curve control As I just said, QQE has brought about a steady improvement in Japan’s economy, but the price stability target of 2 percent is yet to be achieved. The main reason for this is that inflation expectations remain weak after having made a clear but temporary increase upon the introduction of QQE. Compared to the United States and Europe, inflation expectation formation in Japan is judged as being largely adaptive, meaning that the expectations are formed in accordance with developments in the observed inflation rate. Against this background, reflecting a substantial fall in crude oil prices since summer 2014 and a slowdown in emerging economies from 2015 through 2016 accompanied by turbulence in the global financial markets, the observed inflation rate declined, dragging down inflation expectations as well. The Bank aims to drastically convert the deflationary mindset entrenched among people and re-anchor inflation expectations at 2 percent, but this has met with difficulties. Given that QQE is unprecedentedly powerful, due attention also has to be paid to side effects that could materialize going forward. If an excessive decline in and a flattening of the yield curve were to last for too long under powerful monetary easing, risks of a pullback in financial intermediation and of destabilizing the financial system through downward pressure on financial institutions’ profits could not be ignored. If these risks were to materialize, the transmission mechanism of monetary easing would be hampered and it would become more difficult to achieve price stability and sustainable economic growth in a self-fulfilling manner. It was judged that the Bank has to achieve the most appropriate interest rate level with a view to containing such side effects to the minimum. Bearing these issues in mind, the Bank introduced “QQE with Yield Curve Control” last September. This new policy framework was established through a further evolution of QQE, consisting of mainly two components (Chart 7). The first is yield curve control, which was introduced with the aim of realizing the combination of the levels of interest rates that are deemed most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, while also considering the effects on the functioning of financial intermediation. Under this framework, Japan’s yield curve during this one year has been formed smoothly in a manner consistent 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 the 10-year JGB yields at around zero percent. The second component is an inflation-overshooting commitment, which aims at ensuring that inflation expectations will be anchored at 2 percent. This is a further powerful commitment by the Bank; namely, it is committing itself to 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, not the outlook. We judged that, in Japan, where inflation expectation formation is largely adaptive, people’s perception of prices cannot be changed without experiencing the inflation rate actually exceeding 2 percent for some time, and this is why this commitment was introduced. 8 / 15 BIS central bankers' speeches The novelty of yield curve control lies in the feature that it more directly affects long-term interest rates with setting 10-year JGB yields as the operating target. This is a further reinforcement of the first approach of the aforementioned category of evolution. The inflation-overshooting commitment can be regarded as a further enhancement of the fourth approach, as the aim is to work on people’s inflation expectations more strongly. With these two unprecedented and innovative policy tools, the Bank of Japan once again embarked on navigating the uncharted waters of unconventional monetary policy. As a matter of fact, I received many questions in the past year, such as those regarding the actual operation of yield curve control. Today, I would like to take the opportunity to answer some of those key questions. The first question is whether the Bank’s current operating target is quantity or interest rates. As I mentioned earlier, the current monetary policy aims to facilitate the formation of a yield curve that is deemed most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, so in that sense, the answer is “interest rates.” The most appropriate shape of the yield curve cannot be formed by fixing the amount of JGB purchases as an operating target. This is because, even though the same amount is to be purchased, the degree to which interest rates will be lowered depends on the economic and inflation conditions as well as the conditions of the JGB market. In contrast, yield curve control enables the Bank to purchase just the right quantity of JGBs in a flexible and effective manner to achieve the operating target of the policy. Consequently, the amount of JGB purchases is determined endogenously. In addition, even if JGBs to be purchased by the Bank become scarce at some point in the future, the impact of a unit amount of its JGB purchases on long-term interest rates accordingly should become more significant, with all else being equal. This means that, under yield curve control, the Bank can achieve the same interest rate level with a smaller amount of JGB purchases. Yield curve control is designed to be flexible and highly sustainable, through which the most appropriate level of interest rates can be achieved in line with developments in economic activity and prices as well as financial conditions. 9 / 15 BIS central bankers' speeches The second question, given that interest rates are set as an operating target, is whether controlling long-term interest rates is operationally feasible in the first place. It is obvious from the past year’s experience that the answer is “yes” (Chart 8). While central banks have a dominant power to control short-term interest rates, which can be referred to as prices of the monetary base, long-term interest rates are determined by market participants’ outlook for future developments in short-term interest rates as well as by various risk premiums. Therefore, the conventional view is that central banks can control short-term interest rates but not long-term interest rates. However, as I mentioned earlier, many central banks have been making efforts to exert influence on longer-term interest rates in order to overcome the zero lower bound, and yield curve control would be the ultimate example in terms of the range of maturity of interest rates to be controlled and the level of sophistication of such control. Admittedly, controlling the interest rates is a challenge. But the Bank of Japan has a dominant presence in the market and has built up its experiences of large-scale asset purchases for the past few years. It conducts purchase operations in different maturities across the yield curve and is equipped with a powerful supplementary tool — the fixed-rate full-allotment operations — through which it can purchase an unlimited amount of JGBs at a certain interest rate level. Therefore, I believe it is quite possible to continue to facilitate the formation of a yield curve that is deemed most appropriate for achieving the price stability target of 2 percent, although not as precisely as controlling short-term interest rates. That said, in order to form such yield curve smoothly, I want to underline the importance of closely communicating with market participants. I have full confidence in the operational skills, including this aspect, of our Market Operations Desk. The third question, assuming that it is possible to control the level of long-term interest rates, is how to determine the desirable shape of the yield curve. Under the conventional monetary policies, various benchmarks have been devised to determine the desirable level of short-term interest rates. The Taylor rule would be one of the most famous benchmarks. However, the Bank of Japan needs to establish a new benchmark that can be applied to the entire yield curve, not to a single short-term interest rate alone. As part of devising such benchmarks, it has been 10 / 15 BIS central bankers' speeches proceeding with theoretical and empirical analysis from many aspects. These efforts include measuring the natural yield curve, which can be obtained from expanding the concept of the natural rate of interest, and comparing it with that during the past easing phase. Although not a few issues remain in terms of research, the Bank will make adjustments to the shape of yield curve as necessary, while making use of the outcome of analyses and taking into account developments in economic activity and prices as well as financial conditions. IV. Expansion of monetary policy Monetary policy and financial stability policy I have explained so far how central banks overcame the zero lower bound and their monetary policy made progress. Let me add that the direction of our monetary policy evolution is not necessarily limited to what I have described thus far. During the global financial crisis, the central banks were confronted with new challenges to maintaining financial stability. First, it was recognized that not only banks but also nonbanks can be sources of systemic disruption, as clearly demonstrated by the collapse of Lehman Brothers. Second, there is a possibility that, once market participants become extremely concerned about the creditworthiness of counterparties, an entire market could run out of liquidity as a result of having no counterparties in the market. This situation was realized with the collapse of Lehman Brothers in 2008. At that time, the liquidity squeeze spread from the interbank market to firms’ major funding markets, including those for CP and corporate bonds. It was feared that the breakdown of corporate financing would stagnate business activities and thus the entire economy. Third, the central banks had to ensure access by foreign financial institutions in their own jurisdictions to not only the domestic currency liquidity but also foreign currency liquidity, in particular U.S. dollars. This was reflective of the fact that more financial institutions came to be engaged in operations in multiple currencies. In order to effectively address these new challenges to financial stability, many central banks extended liquidity assistance as the lender of last resort beyond what had been considered the norm under the so-called Bagehot’s rule (Chart 9). Specifically, they provided liquidity assistance to nonbanks to address the risk that deterioration of business conditions at nonbanks could destabilize the financial markets. As a counterparty to many market participants, they conducted funds-supplying operations to revive the markets that had become dysfunctional, and swiftly provided financial institutions with funding liquidity at a large scale in foreign currencies in addition to domestic currencies. 11 / 15 BIS central bankers' speeches When one groups the functions of central banks into monetary policy and financial stability policy, central banks’ policy responses since the global financial crisis fall under the heading of financial stability policy if one emphasizes the aspect of addressing systemic risks. On the other hand, since the financial market is one of the key transmission channels of monetary policy, repairing the impaired market functioning can be deemed part of monetary policy. However, taxonomy does not really matter; the important thing is what is to be done by the central banks, consistent with their mandates. The policy of central banks, either in the form of monetary policy or financial stability policy, is achieved through the provision of liquidity because it is only the central banks that can provide unlimited liquidity. This is why they are expected to keep evolving in order to carry out their mission as a central bank irrespective of which policy area they are categorized into. Global cooperation of central banks The significant advancement in global cooperation and coordination has been a big change for central banks in recent years. As I said earlier, during the global financial crisis, it was recognized that it was becoming difficult for the central bank of a home country alone to prevent a liquidity crisis if a financial institution with a global reach faces foreign currency liquidity shortages. In the meantime, the Federal Reserve entered into a swap arrangement with the ECB and the Swiss National Bank at end-2007, establishing a scheme that could swiftly provide U.S. dollars. Right after the collapse of Lehman Brothers, the Bank of England and the Bank of Japan also entered into swap arrangements with the Federal Reserve, and largely contributed to a stabilization in the global financial markets as an effective backstop to contain the U.S. dollar liquidity crisis. In 2011, when the tension surrounding the European debt problem heightened, six major central banks established a network of bilateral liquidity swap arrangements so that liquidity could be provided in each jurisdiction in any of their currencies. In 2013, the arrangements converted to standing agreements, which remain in place (Chart 10). 12 / 15 BIS central bankers' speeches Although the collective efforts by the central banks resulted in substantial progress in addressing a financial crisis that is global in nature, we became aware of unsolved open issues. These include the allocation of responsibility among relevant central banks, the treatment of collateral, and information sharing, in the case of internationally active banks and nonbanks facing difficulty in funding. I have discussed these matters over the years with President Dudley of the Federal Reserve Bank of New York, who also serves as Chairman of the Committee on the Global Financial System (CGFS) of the Bank for International Settlements (BIS). Under his leadership, a report titled “Designing frameworks for central bank liquidity assistance: addressing new challenges” was compiled by a working group of the CGFS, at which I took the chair (Chart 11). This report analyzes in detail the issues that many central banks faced during the global financial crisis and highlights eight operational challenges that need to be addressed going forward. Assuming that the next financial crisis — if it were to occur — would have a global impact, I sincerely hope that central bankers in the next generation will address these challenges in advance. 13 / 15 BIS central bankers' speeches 14 / 15 BIS central bankers' speeches Closing remarks It seems we are almost running out of time. Based on the Bank’s long experience of working on addressing financial crises and overcoming deflation, I would like to close my speech today by emphasizing the importance of becoming an experienced practitioner. Over the past decade, central banks have faced various difficulties and the monetary policy framework has been changing dynamically. Every time central banks faced tough challenges and decided to introduce unprecedented policy measures — such as large-scale asset purchases and negative interest rates — the decision was made based on the operational feasibility, for example, of monetary operations and whether a close cooperative relationship between a central bank and market participants is well established. Needless to say, we, as central bankers, should study the latest theories and make efforts to enhance analytical ability. However, while that is necessary, it is not sufficient to swiftly deal with issues that actually unfold. Policymakers cannot run away from the challenges they face on the grounds that they do not have enough theoretical background. A central banker must be strongly mission-oriented in a manner consistent with the central bank’s mandate and make necessary and timely decisions, fully being aware of policy effects and possible accompanying costs, while being accountable. To ensure the right decisions, we have to constantly upgrade our skills as practitioners while listening carefully to what market participants have to say. Today, I have focused on unconventional monetary policy, although whether the policy is actually unconventional or not can only be determined on a relative basis and perhaps through the use of retrospective wisdom. After all, contemporary monetary policy has not yet allowed for the accumulation of sufficient experience to enable us to define conventional monetary policy. The evaluation of the experience gained over the decade in the course of monetary policy’s evolution and the decision of how to move forward shall be made by you, who are responsible for the next generation. The central banking community is a very special one in which common values and cultures are shared. That is why we say “once a central banker, always a central banker.” Looking back at the almost 40 years of my service at the central bank, there was not a single moment when I regretted being a central banker. I can assure you that the cooperation and personal relationships with central bankers in other countries is irreplaceable and invaluable for all of you. I do hope that you will make the most of the opportunity, like today’s seminar, to meet other countries’ central bankers of the same generation in person and build ties within the central banking community. I would like to conclude my speech by once again welcoming you all to the central banking community and expressing my hope that your journeys in central banking life continue to be interesting and exciting. Thank you. 15 / 15 BIS central bankers' speeches
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Fourth FinTech Forum, Tokyo, 1 November 2017.
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Hiroshi Nakaso: Big data – its impacts on economies, finance and central banking Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Fourth FinTech Forum, Tokyo, 1 November 2017. * * * Introduction: Data and Power It is a great pleasure to welcome you all today to the fourth meeting of the FinTech Forum. Today I would like to talk about big data and its utilization. The importance of data itself is not new to all of us. History tells us that many kings, lords, and governments, put their first priority on collecting data to understand their lands’ geographies, populations, and taxable capacities. Furthermore, they made efforts to utilize the collected data. It has been the source of their political and economic power to collect high quality data and utilize it efficiently. Today, in light of the development of the Internet, smartphones, and SNS, the amount of data flowing into our society has been rapidly increasing. On the other hand, new technologies such as artificial intelligence (AI) enable us to process large volumes of data in a swift manner. Against the background of these rapid increases in the volume of data, and significant improvements in processing capacity, big data draws significant attention as a potential game-changer in our economy and society. To describe how data utilization has evolved over years, I would like to use the example of maps. Over the years, many people have attempted to make maps as accurate as possible, which have provided us with remarkable benefits. Even today we enjoy the benefits of using geographical data, such as “Google Maps.” However, what is different from the past is that we are no longer users of data only. Our access logs to these services themselves constitute a new set of big data, and potentially have their own value to be utilized. In today’s society, data is a kind of resource, and power belongs to those who are able to collect and efficiently utilize such big data. It is analogous to the economic power of countries with large amounts of petroleum resources, which was increased after they enhanced their processing capacity and sales channels. I. Economic and Financial Developments and Data Utilization History of data utilization The world economy has also developed along with the evolution of data utilization. In this sense, one of the largest breakthroughs in economic history was the birth of money. When people exchanged goods, or bartered, the values of these goods were measured only in relative terms on a bilateral basis. However, the birth of money enabled them to use a common measure of value, and turned the value of each good into a datum, called a “price.” Such price data also served as a foundation for the pricing mechanism to adjust the demand and supply of goods. Moreover, money made it much easier for people to trade with each other. Under the bartering system, each participant had to find a counterpart with a mutual demand for trading. However, money’s intrinsic function of representing value, i.e. its price, has enabled people to trade without necessarily finding such a coincidence. Since money contains data about prices, it also made it easier to store wealth by keeping it in the form of money. This feature has also enabled us to do “inter-temporal trading", such as obtaining money by selling a fish yesterday and using it for the 1/5 BIS central bankers' speeches purchase of fruits tomorrow. Data Utilization Today As those episodes suggest, data utilization and the development of the economy have been strongly connected with each other. Today it is not an exaggeration to say that every economic activity is inseparable from collecting and processing data. For instance, demand forecasts, and production planning and inventory management by firms, consist of large amounts of data processing. Above all, the financial industry is one of the most data-oriented businesses. For example, the operations taking place on the back of our daily payments and settlements via credit cards, debit cards, or deposit accounts, can be regarded as data processing. Banks provide financial intermediation services through making complicated decisions and assessments on borrowers, interest rates, and assets for investments, by collecting and analyzing various types of data. Insurance companies design insurance policies and set their fees at appropriate levels by also collecting and analyzing data. These insurance schemes allow society to efficiently redistribute risks among various entities, and enhance its resiliency against future uncertainty. As such, the financial and insurance industries have indeed promoted economic growth in modern and postmodern society. II. IT Revolution and the Potential of Big Data The emergence of big data Unlike tangible assets, information and data never depreciate. Data also has an interesting feature; that is, the marginal benefit of data may even increase as more data is collected and accumulated. In the past, collecting, storing, and processing, large amounts of data had been difficult in many cases due to technological constraints. Today however, the IT revolution has been changing the situation unprecedentedly and enabling efficient collection, storage, and processing, of gigantic amounts of data. This drastic change can be easily seen in the quantity of data. As the Internet, smartphones, and SNS, are expanding, the amount of data flowing in our economy is also increasing very rapidly. This is the emergence of big data. Moreover, in accordance with the IT revolution, more tactical and sophisticated methodologies for collecting data have become available. For example, unlike the past when doing paper-based surveys was the main instrument to collect customer data, firms have become able to obtain data without direct contacts with customers or individuals. For example, they can collect data that people disclose on the internet via SNS voluntarily, or that their customers input when conducting searches, or from e-commerce websites. Firms can also collect data even without their customers’ explicit intention to provide data. For example, they can collect customers’ data related to their purchasing activities by offering new digitized payment instruments, or obtain customer information by offering economic incentives such as special discounts to customers that provide their data through loyalty cards. Another remarkable change has been seen in the capacity to process data. Today we are becoming able to process big data very rapidly by utilizing innovative information technologies such as AI. Furthermore, a large amount of graphical or sound data, which was difficult to use in the past, is becoming easier to be efficiently utilized through technologies such as “deep learning,” in which AI automatically learns by itself through digesting such data. Potential of big data on the economy 2/5 BIS central bankers' speeches As such, rapid increases in the volume of data, and significant improvements in its processing capacity, are exerting a big influence on the economy and financial services. Currently, companies such as Google and Amazon, which are now at the world’s top level of market capitalization, are collecting and leveraging big data through utilizing their platforms covering the world, and making it a source of their added-value and profits. In this regard, big data can be seen as a new type of “asset,” in terms of a profit source, instead of traditional fixed assets such as branches. Indeed, neither Google nor Amazon has physical “branches” in a traditional manner. Moreover, new businesses such as the sharing economy, can also be made possible by utilizing big data for connecting various idle resources and needs scattered all over the economy. For a wide range of companies, including giant global companies or new industries, the utilization of big data and AI may improve productivity in various ways, such as accurate analysis on demand, more efficient business processing, and enhancing added value. In emerging and developing countries with large populations, several e-commerce enterprises, backed by rapid popularization of smartphones, accumulate gigantic amounts of customer data, and the utilization of that data has facilitated the expansion of various businesses and economic activities in those countries. Potential of big data on financial services Big data may also extend the frontiers of financial services. Firstly, financial services themselves can be more sophisticated through effective use of big data. By using customers’ transaction data to grasp their needs and analyze risks, it becomes easier to provide customized financial services tailored to each user, and to flexibly adjust the contents of services if necessary. For example in the field of insurance, in order to overcome “adverse selection” and “moral hazard,” which have been regarded as inherent problems in the insurance industry, efforts are being made to finely adjust the insurance fees by using a new technology known as a “smart contract,” and collecting a wide range of data such as how customers drive, and how they manage their health. Moreover, new authentication technologies such as biometrics authentication through big data analysis enable customers to use various financial services in a more secure manner. Secondly, big data may facilitate the networking of financial services with broad industries. For example, safe and efficient payment instruments are extremely important for e-commerce and the sharing economy. On the other hand, data obtained through these businesses can be useful for providing and customizing financial services. Consequently, new networks between financial services and various industries can be established, such as linking retail sales businesses with payments, loans, and insurance services. Thirdly, big data may also enhance financial stability through facilitating refined risk management and the efficient allocation of risks. However, when a variety of entities which are different from traditional financial service providers enter financial services, central banks are required to closely monitor their impacts on financial stability and their structures. Data security issues Along with the enhanced utilization of big data, cyber security, data protection, and stakeholders’ consent on the usage of big data, are becoming all the more important. Since “trust” has an important meaning especially in finance, these issues are becoming critical factors for 3/5 BIS central bankers' speeches maintaining the stability of payment settlement systems as well as financial systems. Recently, enormous amounts of non-anonymized data such as, who bought what, when, and where, are being collected. While such accumulation of non-anonymized data substantially enlarges the potential of data usage, the relevant entities are required to pay extremely careful attention to data protection and privacy. If people were to worry about the practices of managing big data and feel uneasy about their own privacy, it would become difficult to make big data contribute to economic development and welfare. Thus, I would like to ask all the relevant entities, who collect and utilize data, to pay due attention to ensuring data security. III. Big Data and Central Banking Big data also has substantial implications for central banking. All the operations and policy conduct of the central bank are closely linked with data collection and processing. Every operation including the settlement of funds and securities, and the processing of treasury funds through daily operations of the central bank’s system, the core infrastructure of the economy, is made up of gigantic amounts of data processing. In carrying out macro policies such as monetary policy, it is an important precondition that policy entities including the central bank can collect and analyze various types of economic data quickly and efficiently, and timely grasp the developments of aggregate demand, general prices, and the impacts of policy actions on the economy and financial markets. Indeed, many central banks, including the Bank of Japan, are collecting and aggregating large amounts of data such as price statistics, corporate surveys, and financial market data, by themselves. Since central banks are processing as well as utilizing large amounts of data, central banks are required to continuously examine how to utilize and leverage new technologies for collecting, processing, and analyzing various types of data. IV. Closing Remarks I think that big data has great potential to vitalize various economic activities, innovate financial services, and increase economic welfare, as long as data security is firmly secured. In the well-known movie “Moneyball,” open-minded and thorough analysis of data, free of prejudice and convention, leads to the finding of new and advanced strategies that drastically change traditional baseball tactics. Also in volleyball, the current offense strategy with multiple options of attack including those from backguards, which is supported by precise data analysis, has been widely adopted in recent years, which I could not imagine when I was coaching high school students decades ago. As such, analysis and utilization of data has demonstrated its potential in various areas more than ever before. Given rapid increases in the volume of data and significant improvements in its processing capacity, I also have great expectations for the possibilities that utilizing data will increase opportunities for serendipity, that is, lucky encounters with unexpected discoveries or events, and will lead to creations that open up new frontiers. I believe that big data has huge potential to lead to new creations and value-added seeds which are free from prejudice, going beyond the psychological “wall” formed by conventional business customs. I think that such cases are already being seen. In order to maximize the opportunities for such serendipity, positive dialogues among a wide range of stakeholders are critical and indispensable. I would be very happy if this forum could become the place where such new creations and discoveries are made. 4/5 BIS central bankers' speeches I would like to close my remarks now by wishing that today’s FinTech Forum be fruitful for all the participants. Thank you for your attention. 5/5 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, Hakodate, 18 October 2017.
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Makoto Sakurai: Economic activity, prices, and monetary policy in Japan Speech by Mr Makoto Sakurai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate, 18 October 2017. * * * I. Economic Activity at Home and Abroad: Recent Developments and the Outlook A. Overseas Economies Let me start with developments in overseas economies. Overseas economies have continued to grow at a moderate pace. Trade activity was sluggish globally following the financial crisis of 2008, but has recovered since the second half of 2016, providing support for the recent growth in the global economy. In many countries, business fixed investment has been increasing, accompanied by an improvement in corporate profits. Private consumption has also been solid against the background of an improvement in the employment and income situation. Global financial markets have responded temporarily to the increasing seriousness of the situation regarding North Korea, but so far, there have been only limited signs of investors’ risk aversion. Let me elaborate on developments by region. The U.S. and European economies have continued to recover firmly. Exports have been increasing moderately as global trade activity has recovered. Private consumption has been on a trend increase against the background of an improvement in the employment and income situation. Meanwhile, an upturn in business fixed investment has continued, accompanied by an improvement in corporate profits. Although economic activity in the United States is likely to be temporarily slowed by the effects of the recent powerful hurricanes, experience suggests that the economy will maintain its momentum toward recovery, underpinned in part by demand for reconstruction. The European economy has been experiencing a further increase recently in its cyclical momentum toward recovery, in a situation where uncertainties have been easing following events such as elections in major countries in the region. Let me turn to emerging economies. The Chinese economy has continued to see stable growth on the whole. The momentum for growth in fixed asset investment in the private sector has slowed, due in part to the cumulative effects of monetary tightening, but public investment has maintained high growth under fiscal policy conducted in a timely manner. Exports have been on a pick-up trend, and private consumption has been resilient against the backdrop of a favorable employment and income situation. In the NIEs and ASEAN countries, with an uptrend in exports, domestic demand has been resilient, on the back of an improvement in business and household sentiment and the effects of economic stimulus measures in these countries. A recovery trend in commodity-exporting economies has been apparent recently, partly reflecting a bottoming out of commodity prices. In terms of the outlook, moderate growth in overseas economies as a whole is projected to continue. Advanced economies are likely to continue growing steadily, and a recovery in emerging economies is expected to take hold on the back of the steady growth in advanced economies and the effects of policy measures taken by emerging economies. According to the October 2017 World Economic Outlook (WEO) released by the International Monetary Fund (IMF), the global growth projection represents an upward revision from the previous estimate made in July 2017; global growth is now expected to rise from 3.2 percent in 2016 to 3.6 percent in 2017 and 3.7 percent in 2018, picking up pace. 1/7 BIS central bankers' speeches Needless to say, the outlook is not free from uncertainty. For example, particular uncertainty seems to remain in the United States over economic policy management, including tax reform. In a situation where further normalization of monetary policy by the Federal Reserve is in sight, the impact of U.S. interest rate hikes on the global flow of funds is an issue which also calls for close attention. As massive capital inflows have been observed in some emerging economies since 2016, there is the risk of an increasing impact should there be a reversal of funds. Moreover, geopolitical risks have been heightening, including with regard to North Korea. Negotiations on the United Kingdom’s exit from the European Union (EU) and the effects they will have are also risks to the outlook. In the longer run, I believe that particular attention must continue to be paid to the growing protectionist mood of recent years. The establishment of supply chains through trade and direct investment has long been driving global economic growth. If the protectionist mood gains traction, this will limit trade and direct investment, making it necessary to rebuild existing supply chains. This could cause significant disruption to the global economy and deprive it of its main growth engine. Keeping a watchful eye on these uncertainties, I will continue to carefully monitor overseas developments. B. Recent Developments in Japan’s Economy Next, I will discuss developments in Japan’s economy. The economy is expanding moderately. Exports have continued on an increasing trend, reflecting moderate growth in overseas economies. The implementation of the government’s large-scale economic stimulus measures has made progress, and the synergy effects between monetary and fiscal policies have become profound. A virtuous cycle operating from income to spending has become stronger in both the corporate and household sectors, and economic growth is in the process of shifting from one led by external demand, to a more self-sustaining one accompanying a recovery in domestic demand. Improvements have been seen in wider sections of the economy; from urban areas to regional areas, and from large firms to small firms. In this way, I feel that the robustness of the economy has been further enhanced. The GDP growth rate has increased for six consecutive quarters for the first time since 2006; the annualized rate of average quarterly growth during this period marked relatively high growth of 1.7 percent, thereby maintaining a significantly higher figure than the potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. This shows that the output gap — an indicator of the utilization of capital and labor — has clearly improved. This consecutive growth for several quarters also seems to have steadily exerted a positive influence on household and business sentiment. Looking at developments in detail, in the corporate sector, exports have followed an increasing trend, particularly in automobile-related and capital goods. Corporate profits have been improving markedly since the second half of 2016. According to the Financial Statements Statistics of Corporations by Industry, Quarterly (FSSC), the seasonally-adjusted ratio of current profits to sales for all industries and enterprises reached the historically high level of 6.16 percent in the April-June quarter of 2017. Business sentiment has also been improving. In the Bank’s September 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) released on October 2, the diffusion index for business conditions for all industries and enterprises — the proportion of firms responding that business conditions were “favorable” minus the proportion of those responding that they were “unfavorable” — reached its highest level since 1991, when the economy was experiencing an asset bubble. Improvements in economic activity have been observed in many regions and firm sizes, making it possible to conclude that the recovery has been spreading across wider economic entities. I believe this is one of the salient characteristics of the current economic expansion phase. In this situation, business fixed investment has been on a moderate increasing trend, mainly in investment related to the Olympic Games and the redevelopment of urban areas, and labor-saving and efficiency-improving investment to address labor shortages. Firms planned to substantially increase their business fixed investment for fiscal 2017 compared with the plans they made in the previous fiscal year. The rate of increase was up 6.9 percent for all industries, including the financial industry, according to the September Tankan, 2/7 BIS central bankers' speeches and up 11.2 percent for major firms in all industries, according to a survey conducted by the Development Bank of Japan. Let us turn to the household sector. Labor market conditions have tightened steadily, as the number of employees has continued to increase. The active job openings-to-applicants ratio registered 1.52, exceeding the peak level observed during the bubble period, and reaching the even higher level seen in the first half of the 1970s. The unemployment rate is currently 2.8 percent, which essentially represents a situation close to full employment. Wages of part-time employees, which are responsive to labor market conditions, have risen markedly, but wages of regular employees — the majority of employees — have only increased moderately. Private consumption has increased its resilience against the background of improvement in the employment and income situation. This resilience seems to have been underpinned by, for example, the replacement of durable goods, which consumers were encouraged to purchase by a number of demand-boosting measures implemented following the financial crisis, including the eco-point system for energy-efficient household electrical appliances. Private consumption has also been supported by large-scale economic stimulus measures carried out last year to support households, such as lowering employee insurance premiums. As seen also in Hakodate, consumption by foreign visitors to Japan — which has been on an uptrend in recent years — is contributing to sales at retail stores and in the services sector, not only in urban areas but across wider regions in Japan. On this basis, from an overall perspective, despite the steady improvement evident in economic activity as a whole, wages have been slow to recover. Some people suggest that this is due to Japan’s employment practice, which places importance on securing jobs. Firms are cautious about raising regular employees’ wages because they are difficult to cut even during periods of recession, and labor unions seem to be reluctant in general to demand sharp wage hikes, since they prioritize stability of their employment in the long run. Moreover, an increase in the labor supply in recent years — resulting in part from the government’s initiatives to promote the empowerment of women and the elderly — has been another factor in easing any upward pressure on wages. Especially, in practice, considering that wages paid to women and the elderly tend to be low, my view is that firms facing a labor shortage have consequently been able to obtain low-cost labor. C. Outlook for Japan’s Economy As for the outlook, Japan’s economy is likely to continue its moderate expansion, mainly supported by the growth in overseas economies and the synergy effects between monetary easing measures and stimulative fiscal measures. In the corporate sector, profits are projected to follow an increasing trend due to growth in demand at home and abroad. Exports are likely to maintain their increasing trend as global trade activity continues to recover. Business fixed investment is expected to continue to see a moderate increase on the back of the improvement in corporate profits and accommodative financial conditions. As for the household sector, upward pressure on wages is likely to strengthen further with the increase in demand for labor. Private consumption is expected to follow a moderate increasing trend as there will continue to be replacement demand for durable goods, and the employment and income situation will continue to improve. In the light of these developments, the positive output gap is also expected to widen further, as the economy is likely to continue growing at a relatively high pace above its potential. II. Prices A. The Current Situation of Prices 3/7 BIS central bankers' speeches Next, I will turn to price developments, an issue of much interest in Japan recently. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has increased to 0.7 percent. The rise in energy prices has contributed to the increase in the CPI, against the background of a pick-up in crude oil prices since the spring of 2016. It must be noted, however, that developments in the CPI for all items less fresh food and energy remain relatively weak, with the year-on-year rate of change standing at 0.2 percent. In a situation where wages are increasing, albeit moderately, firms are facing higher labor costs. However, instead of directly passing on the cost increases to sales prices, most firms are trying to absorb these increases by improving productivity. Among the initiatives they have adopted are: (1) streamlining of excessive services and inefficient business procedures, including discontinuation of late-night business and reduction of parcel delivery time slots; (2) more efficient reallocation of human resources, including sending staff temporarily to different departments when necessary, for example, from an administrative to an operational section; and (3) investment in labor-saving and efficiency-improving machinery and equipment, including installment of self-checkout machines, full automation of distribution facilities, and adoption of online booking systems. Behind firms’ reluctance to pass on cost increases to sales prices is the fear of losing customers. While this is not surprising given the highly competitive business environment they are in, I believe that the following factors are responsible for further heightening this fear. First, given that the inflation rate has remained stable at an extremely low level for the past few decades, I believe firms have become increasingly afraid to raise prices because consumers are not accustomed to price hikes, or because firms anticipate a negative reaction to price rises from those consumers. And second, the widespread use of smartphones and the expansion of e-commerce may have had an impact. Consumers can now easily refer to and compare a wide range of information on prices at the press of a button, and purchase goods and services as necessary, even from a distance. I believe these changes have increased convenience for consumers while, at the same time, increasing their responsiveness to prices, consequently somewhat accelerating price competition among firms. B. Outlook for Prices That being said, I do not believe that firms will be able to avoid price hikes forever. Cost cutting efforts such as streamlining of business processes and efficient reallocation of human resources have their limitations. It will gradually become difficult for firms to absorb increases in labor costs even if they are reluctant to raise prices. In this situation, competing firms in the same environment are likely to be faced with similar limitations. Therefore, I believe there will be cases of a price hike starting at an individual firm, followed by hikes at competing firms. Once price hikes actually start to become common, consumers are, to some extent, likely to accept increases in prices as a matter of course. Subsequently, there will be even greater room for firms to raise prices. Employees will then start to demand a raise in wages to reflect these price increases. Under such a cyclical mechanism, the uptrend in the inflation rate is likely to gradually strengthen toward the 2 percent price stability target. It is difficult to predict precisely when such a cyclical mechanism will start to operate. Having said that, however, I would like to point out that some firms, in the transportation and food service industries for example, have begun to raise prices due to increasing labor costs. There are also frequent news reports that more firms are considering raising prices in the near future. While the situation may differ largely by industry, my view is that, in general, the momentum toward price hikes is starting to increase. Moreover, I feel that the perception of the general public toward price hikes has gradually become more positive recently, as reflected in major rises in the price of stocks of firms that have announced price hikes. In other words, given the evidence of successful cases of price increases, more people have begun to think that firms do not always 4/7 BIS central bankers' speeches lose customers by raising the price of the goods and services they offer. Consumers might be gradually showing their understanding of the situation firms are placed in, hearing more frequent news reports of labor shortages. In sum, despite the relatively weak price developments at present, a cyclical mechanism toward price increases is likely to operate going forward, as labor market conditions tighten further with improvements in economic activity. There are signs of such a mechanism working, and in my judgment, a process toward price increases has been evolving steadily. III. Monetary Policy A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control In September 2016, the Bank introduced QQE with Yield Curve Control as a new framework for strengthening monetary easing. The framework consists of the two components of an inflationovershooting commitment and yield curve control. Under the inflation-overshooting commitment, the Bank commits itself to continuing to expand the monetary base until the observed year-on-year rate of increase in the CPI, for all items less fresh food, exceeds the price stability target of 2 percent and stays above the target in a stable manner. For people to regard a rise in prices of around 2 percent every year as a matter of course, I believe it is important that the Bank shows such strong commitment and that people actually experience an inflation rate of above 2 percent. Under yield curve control, the Bank facilitates the formation of short- and long-term interest rates that are considered most appropriate in light of the 2 percent price stability target. In the Bank’s current guideline for market operations, the short-term policy interest rate is set at minus 0.1 percent and the target level for yields on 10-year Japanese government bonds (JGBs) is set at around 0 percent. Since the introduction of yield curve control a year ago, short- and long-term interest rates have thus far been maintained at levels consistent with the guideline for market operations. Meanwhile, with the shift in the Bank’s main operating target from quantity to interest rates, I believe that the following points have been confirmed. First, the amount of the Bank’s JGB purchases varies according to financial market conditions at the time and the progress in its cumulative purchases of JGBs. And second, as a result of this, the sustainability of the Bank’s policy framework has increased. B. Future Conduct of Monetary Policy At present, price developments are relatively weak, and the inflation rate is fairly distant from the 2 percent price stability target. The Bank should face this fact with sincerity. Nevertheless, as I discussed earlier, Japan’s economy has been improving solidly and the process toward price increases has been evolving steadily. When long-term economic growth potential is increasing and people’s views on prices are changing, the real interest rate level that is considered to be neutral to economic activity — the natural rate of interest — will rise and the observed real interest rates will decrease. This, in turn, is expected to further enhance the effects of monetary easing. Taking these points into account, I believe that it is important that the Bank, for the time being, continues to firmly pursue powerful monetary easing under the current policy framework. Recently, some have come to believe that the price stability target of 2 percent is too high, due in part to improvements in economic activity. I, however, am of the opinion that the Bank should not readily change the 2 percent price stability target, because this target was set after giving due consideration to domestic and overseas circumstances. Let me elaborate on this point. First, the CPI has a statistical tendency to assert a higher inflation rate than the inflation that people actually experience. Therefore, in order to ensure that people actually experience price stability, the rate of change in the CPI should be sufficiently positive. Second, the room for monetary policy responses is not symmetrical on the upside and downside, and there is relatively limited 5/7 BIS central bankers' speeches scope for responding to deflation, compared with inflation, because it is difficult for the Bank to lower interest rates to a level substantially below zero. That is why it is considered desirable, under normal circumstances, to ensure that the inflation rate be positive, to a certain extent. And third, targeting inflation at 2 percent is a global standard shared by major advanced economies. Pursuing the same rate of inflation at 2 percent will contribute to the stability of foreign exchange rates in the long run, as well as price stability. IV. Expansion of the Economy’s Supply Capacity I have pointed out various factors behind the delay in improvements in wages and prices. To summarize, I consider one of the major reasons behind the delay to be the expansion of the economy’s supply capacity caused by an increase in the labor supply and by firms’ efforts toward increasing productivity. I would like to elaborate on this, because it is particularly important in considering the outlook for economic activity and prices in Japan. Starting with labor supply, the labor force participation rate in Japan rose by 1.8 percentage points over the five years to August 2017. Over the same period, the size of the labor force increased by 1.92 million, and this accounts for nearly 70 percent of the 2.82 million increase in the number of employed persons. The trend in the labor force participation rate started to rise markedly from around 2012. Indeed, the growth in labor force participation was remarkably rapid, considering the downward pressure on the participation rate stemming from an increasingly aging population. This reflects various structural changes in the economy resulting from, for example, measures to promote the empowerment of women and the elderly, including the provision of child-rearing and nursing care facilities, as well as extending the retirement age or abolishing traditional retirement systems amid the increase in life expectancy. I believe that these structural changes have eased the upward pressure on wages and prices by providing additional labor force to firms facing labor shortages. Japan’s productivity has shown relatively high growth in recent years, compared with other major advanced countries, as reported for example by a U.S. private institute, although productivity figures should be regarded as being subject to a considerable margin of error because of their large measurement bias. It has been said that Japan’s productivity is low, but this could also be taken to mean merely that there is large room for improvement. As I have already mentioned, most firms are currently trying to improve productivity, and my assessment of the current situation in Japan is that, due to labor shortages, productivity is growing sharply to catch up with other countries. Naturally, such an expansion in supply capacity raises the economy’s long-term growth potential. Enhancing growth potential is an extremely important issue for Japan, which is facing a decline in population. A fall in growth potential can lead, for example, to concerns about fiscal sustainability and to restraints in firms’ and households’ spending due to anxiety about their long-term economic outlook. In this regard, although recent developments in supply capacity may exert downward pressure on wages and prices in the short run, they will definitely bring positive effects to the economy as a whole. I believe that the recent GDP growth — which was positive for six consecutive quarters — is attributable not merely to cyclical factors but also to these structural changes in the economy. The Bank, for its part, does not focus solely on raising prices. I believe that it is essential to achieve price stability while the virtuous cycle in the economy continues to operate and the quality of people’s lives improves. A joint statement released by the government and the Bank in 2013 stated that they aim “to overcome deflation early and achieve sustainable economic growth with price stability.” My assessment of recent developments in the economy is that they are in line with such an objective. Even if we focus on how wages and prices are affected by the increase in supply capacity, I do not think that it necessarily exerts a negative effect in the long run. As I explained earlier, there is a natural limit to the rise in the labor force participation rate, the streamlining of firms’ business 6/7 BIS central bankers' speeches processes, and the efficient reallocation of human resources. Therefore, the downward pressure on wages and prices resulting from such efforts will dissipate eventually. Let me also note that, in the long run, there are mechanisms through which an expansion in supply capacity leads to an increase in wages and prices. First, firms’ expectations of higher profits and a rise in households’ permanent income stimulates the demand side of the economy, such as business fixed investment and private consumption. Second, when firms’ long-term outlook for the business environment starts to improve, they are likely to shift their stance toward raising wages. Third, since the rate of growth in labor productivity corresponds to the rate of increase in real wages in the long run, a rise in productivity also exerts upward pressure on wages. And fourth, an increase in the economy’s long-term growth potential leads to a rise in the natural rate of interest, enhancing the effects of accommodative monetary policy measures. Given these points, it is likely that, as time passes, the long-term positive effects of an increase in supply capacity will gradually outweigh the short-term negative effects on wages and prices. In other words, although an expansion of the economy’s supply capacity may delay rises in wages and prices, I do not think that it will hold them back for any protracted period. In my view, therefore, Japan’s economy is currently experiencing adjustments arising from positive structural changes. There is no need to be unduly pessimistic simply on account of the current low growth rates in wages and prices. Rather, I personally find the current state of the economy to be very promising, since both demand and supply are improving in a balanced manner, and developments in wages and prices are steadily making progress toward increases. What is crucial in this situation is not to hinder these positive developments. To this end, I think that it is important that the Bank continues to pursue powerful monetary easing under the current framework for monetary policy. At the same time, I hope to see continued progress in the various initiatives and efforts by the government and firms toward strengthening the economy’s growth potential, including structural reforms. 7/7 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, 6 November 2017.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the University of Zurich, Zurich, 13 November 2017.
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November 13, 2017 Bank of Japan Quantitative and Qualitative Monetary Easing and Economic Theory Speech at the University of Zurich in Switzerland Haruhiko Kuroda Governor of the Bank of Japan Introduction I am very honored to have the opportunity to give a speech at the University of Zurich today. I also would like to express my sincerest gratitude to the Swiss National Bank for arranging this valuable occasion. At present, the Bank of Japan is pursuing powerful monetary easing under the framework of quantitative and qualitative monetary easing (QQE), with a view to achieving the price stability target of 2 percent. In my speech today entitled "Quantitative and Qualitative Monetary Easing and Economic Theory," I would like to talk about the following three points. First, I will outline Japan's experience with deflation, which lasted for 15 years and led the Bank to introduce the new policy framework of QQE. Second, I will explain in detail the two pillars of QQE -- the Bank's strong commitment policy and large-scale Japanese government bond (JGB) purchases -- both in terms of theory and practice. Lastly, I will talk about the results QQE has borne to date as well as remaining challenges bearing in mind recent economic debates. I. Japan's Experience with Deflation Leading Up to the Introduction of QQE A. Prolonged Deflation Let me start by talking about Japan's deflation, which lasted for 15 years. Japan experienced a major asset bubble from the late 1980s to the early 1990s. In the course of the burst of the asset bubble, Japan's economy suffered a sharp slowdown and the inflation rate steadily declined. In the late 1990s, the year-on-year rate of change in the consumer price index (CPI) fell into negative territory and, with brief exceptions, remained in negative territory for 15 years (Chart 1). Economic theory points to two possible causes of the prolonged deflation. The first is a decline in the natural rate of interest, while the second is a decline in inflation expectations.1,2 The natural rate of interest is the real interest rate that is neutral to economic activity in that it Paul R. Krugman, "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, no. 2 (1998): 137-205. Jess Benhabib, Stephanie Schmitt-Grohé, and Martín Uribe, "The Perils of Taylor Rules," Journal of Economic Theory, vol. 96, no. 1-2 (2001): 40-69. will neither accelerate nor decelerate the economy. Although the determinants of the natural rate of interest are the subject of considerable debate among academics, it is widely thought that the potential growth rate of the economy plays a major role. Since the nominal policy interest rate has a lower bound of 0 percent, if the potential growth rate or inflation expectations decline, real interest rates remain high compared with the natural rate of interest and financial conditions cannot be sufficiently accommodative. 3 As a result, it becomes difficult to overcome deflation. During the deflationary phase in Japan, both the natural rate of interest and inflation expectations seem to have declined. While coping with the aftermath of the burst of the asset bubble, many economic entities such as firms and financial institutions were slow to respond to drastic changes in the economic environment such as globalization and advances in information technology. Against this background, Japan's potential growth rate declined from around 4 percent in the early 1990s to around 1 percent in the late 1990s. The decline in the potential growth rate continued in the 2000s, reflecting the aging of the population, which was progressing at a faster pace than in other major economies (Chart 2). Meanwhile, with actual inflation being slightly negative, inflation expectations also seem to have followed a downward trend. B. Limited Room for a Policy Response With the aim of addressing the prolonged deflation, the Bank of Japan in 1999 introduced the zero interest rate policy, in which the uncollateralized overnight call rate was guided to virtually 0 percent. Then, in 2001, the Bank introduced quantitative easing (QE), increasing monetary base to financial markets. These were path-breaking policy steps at the time, but Japan's economy nevertheless could not overcome deflation. In 2008, with conventional monetary policy measures already exhausted, Japan's economy was dealt a major blow by the global financial crisis. At the time, with the short-term policy With the introduction of negative interest rate policies, the zero lower bound no longer has a literal meaning; however, given for example the presence of banknotes, which for the central bank represent liabilities with no interest, there is a certain limit to the extent to which nominal policy interest rates can be lowered. interest rate at 0.5 percent, there was little room for further reductions. The situation was quite different from that in Europe and the United States, where there was room for a further reduction by 3 to 4 percentage points. With inflation expectations low and little room for a further reduction in nominal interest rates, the Bank's ability to respond was limited. This limited scope for a policy response is one of the major reasons why the economic downturn in Japan was more pronounced than that in Europe and the United States -- which were the epicenter of the crisis -- even though the soundness of financial institutions and the financial system in Japan remained unaffected (Chart 3). In order to overcome deflation, real interest rates need to be well below the natural rate of interest, whose key determinant is the potential growth rate. Since monetary policy cannot raise the potential growth rate directly, the only means that central banks have left at their disposal is to substantially reduce real interest rates. Two key challenges to achieve this are to substantially lower nominal interest rates and to raise inflation expectations. II. Theory and Practice of QQE The two challenges cannot be resolved using conventional monetary policy relying on the control of short-term interest rates. While policy innovations were needed, what we could rely on were established economic theories. The challenge for the Bank of Japan therefore was to come up with concrete policy measures -- derived from economy theory -- that could be implemented in practice. The answer that the Bank came up with was QQE. This policy framework consists of two pillars: a strong commitment policy aiming to work on inflation expectations, and large-scale JGB purchases in order to push down long-term interest rates. A. A Strong Commitment Policy (Forward Guidance) Let me elaborate on the strong commitment policy first. In economic theory, efforts by the central bank to work on people's forecasts and expectations through commitments regarding the future course of monetary policy are called "forward guidance." The importance of working on expectations was recognized by economists long ago. For example, Ralph George Hawtrey, a British economist active in the first half of the 20th century, and John Richard Hicks, one of the leading economists of the 20th century, identified concepts such as "forward-looking monetary policy" and "announcement effects." These concepts were subsequently formalized by Friedman, Lucas, and the New Keynesians. Today, the idea that central banks can work on inflation expectations and increase the effectiveness of monetary policy by demonstrating their strong intention to achieve price stability forms a theoretical pillar of monetary policy in many countries, and is widely employed in policies such as inflation targeting.4 Recent years have also seen vigorous research on the mechanism that central banks -- even when facing the zero lower bound -- can "borrow" easing effects from the future by committing themselves to continuing with monetary easing even if economic activity and prices improve going forward. In 1998, Professor Krugman argued that, in order for Japan to overcome deflation, it was necessary to substantially increase the money supply and make real interest rates sufficiently negative by raising inflation expectations. In 2003, Professor Woodford and Professor Eggertsson -- who was an IMF economist at the time -- argued that, in order to overcome deflation at the zero lower bound, the management of the expectations of private entities was important and that, for this purpose, a commitment to keeping future monetary policy sufficiently accommodative was indispensable.5 On the other hand, in the world of practice, the Bank of Japan has been a pioneer of such forward guidance. When it introduced the zero interest rate policy in 1999, the Bank explicitly committed to continuing with the zero interest rate policy "until deflationary concern is dispelled." I regard this as the first application of forward guidance in practice worldwide. Moreover, in the period of QE from 2001 to 2006, the Bank committed to continuing with QE "until the annual rate of change in the CPI registers zero percent or above in a stable manner." However, these policies were insufficient to overcome deflation. One of the reasons likely is that the natural rate of interest had declined more than expected, but it is probably also the case that the commitment at the time was somewhat ambiguous and the target inflation rate was too low, so that the policies were insufficient to raise inflation expectations. Haruhiko Kuroda, "The Role of Expectations in Monetary Policy: Evolution of Theories and the Bank of Japan's Experience," speech at the University of Oxford, June 8, 2017. Gauti B. Eggertsson and Michael Woodford, "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, no. 1 (2003): 139-211. When it introduced QQE in 2013, the Bank -- in order to properly lift inflation expectations, and keeping latest economic theory fully in mind -- made sure to make a strong and clear commitment that it would achieve the 2 percent price stability target in a responsible manner. In addition, in September 2016, the Bank introduced its inflation-overshooting commitment, which is even more powerful forward guidance. 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 the target in a stable manner. In general, it takes a fair amount of time for monetary policy to affect economic activity and prices, so that it is desirable to take monetary policy decisions well in advance based on the outlook for the future. From this perspective, the current commitment, which clearly states that the policy will be maintained until the inflation target is achieved, is an exceptional step for a central bank and can be regarded as a more powerful measure. B. Large-Scale JGB Purchases Next, I would like to talk about the second pillar of QQE: the large-scale JGB purchases. Since the global financial crisis, in order to overcome the zero lower bound, many central banks have pursued a decline in real interest rates by implementing monetary policy focusing on the longer end, where room for interest rate reductions remained. The most direct method to do this was to lower long-term interest rates through longer-term lending and purchases of long-term government bonds by central banks. However, from the perspective of economic theory, opinions were split as to whether central banks can push down longer-term interest rates, with one view holding that this is possible and the other that it is not. Keynes and, following in his footsteps, Tobin, assuming imperfect financial asset substitution, argued that long-term government bond purchases by central banks will push down long-term interest rates, and this was the mainstream view until the 1960s. However, as financial markets highly developed and Keynesian influence waned, and based on the assumption that arbitrage in financial markets works perfectly, the so-called "Wallace neutrality," holding that asset purchase operations by central banks have a neutral effect on asset price formation, gained traction.6 While economic theory provided these two conflicting views, central banks -- tasked with the conduct of monetary policy -- weighed up the options, taking the limitations and problems suggested by theory into account, and devised new policy schemes. In practice, since the global financial crisis, major central banks including the Federal Reserve have conducted large-scale government bond purchases and have succeeded in pushing down longer-term interest rates. Recent empirical studies also support the view that central bank government bond purchases can significantly push down long-term interest rates.7 Work on the theoretical underpinnings of these observations is still ongoing, but research has been conducted once again on market imperfections and segmentation, focusing on deep-seated demand for government bonds as collateral and some investors' particular preference for investment in long-term government bonds. The Bank of Japan has also purchased government bonds, and on a scale that far exceeds that of major central banks. The size of the Bank of Japan's balance sheet currently is about 500 trillion yen, which is roughly equivalent to Japan's nominal GDP. Given that the balance sheets of the Federal Reserve and the European Central Bank (ECB) are equivalent to about 20 to 40 percent of nominal GDP, I think this demonstrates how massive the Bank of Japan's purchases of government bonds are (Chart 4). The concrete approach of such purchases has also evolved over the past four and a half years. Initially, in order to push down the entire yield curve, the Bank set the quantity target of government bonds to be purchased in a year. This approach has been widely used not only by the Bank of Japan but also by other major central banks, because it is simple to operate in practice. However, a problem with this approach is that the extent to which long-term interest rates fall for a given amount of government bond purchases depends on the economic and price situation as well as Neil Wallace, "A Modigliani-Miller Theorem for Open-Market Operations," The American Economic Review, vol. 71, no. 3 (1981): 267-274. See, for example, Joseph E. Gagnon, "Quantitative Easing: An Underappreciated Success," Policy Brief, no. 16-4, Peterson Institute for International Economics (2016). developments in financial markets. It is therefore possible that interest rates could decline insufficiently to achieve the desirable yield curve or, conversely, could fall too much. In order to solve this problem, the Bank of Japan in September 2016 introduced yield curve control targeting the yield on 10-year JGBs. Due to the large-scale JGB purchases over several years, the Bank has a considerable presence in the JGB market, so that it has corresponding control over long-term interest rates. In addition, as a more fine-tuned means of adjusting interest rates, the Bank decided to introduce a powerful tool called "fixed-rate purchase operations," in which the Bank buys unlimited amounts of JGBs at a specific interest rate level. In fact, for the past year, the Bank has been able to control 10-year JGB yields at the target level, and the yield curve has been formed smoothly in a manner consistent with the guideline for market operations. III. QQE: Results to Date and Remaining Challenges This powerful monetary easing under QQE has been producing remarkable effects. Through a rise in inflation expectations and a substantial decline in longer-term interest rates, the Bank has succeeded in reducing real interest rates to levels well below the natural rate of interest for the first time in its two-decade-long battle with the zero lower bound on the short-term policy interest rate (Chart 5). Against this background, the output gap has improved steadily, and corporate profits have marked record highs. The labor market is very tight, at virtually full employment (Chart 6). On the price front, annual CPI inflation excluding fresh food and energy has been positive as a trend for about four years. This is the first time since the end of the 1990s that such positive developments are being observed in Japan. We judge that the economy is no longer in deflation, which is generally defined as a sustained decline in prices. These developments indicate that Japan's economy has been improving steadily. At the same time, however, annual CPI inflation excluding fresh food has remained in the range of 0.5-1.0 percent. Moreover, while inflation expectations had risen at one point, they have remained in a weakening phase, mainly reflecting the decline in actual inflation resulting from the fall in crude oil prices. As a result of 15 years of deflation, a deflationary mindset -- that is, the perception that prices will not increase easily -- has become deeply entrenched among firms and consumers, and there is still a long way to go before the price stability target of 2 percent is achieved (Chart 7). Therefore, in the last part of my speech, I would like to touch on the challenges that have emerged during the course of the conduct of QQE, bearing in mind recent developments in economic theory. A. Dispelling the Deflationary Mindset The first challenge is how to dispel the deflationary mindset that has become entrenched among people. The Bank's experience in this regard allows two observations. The first is that central banks can work on inflation expectations, as theory implies. This became apparent during the first year of QQE. Inflation expectations responded positively to the Bank's strong and clear commitment to achieving the 2 percent inflation target and its large-scale monetary easing policy to underpin this commitment; as a result, many indicators of inflation expectations showed clear increases in a relatively short period (Chart 8). The second observation is that, even though the forward guidance provided by the Bank of Japan has been much more forceful than that by other central banks, the rise in inflation expectations in Japan has only been moderate. The phenomenon that economic indicators such as inflation expectations seem to respond more moderately to central bank forward guidance than theory predicts has been labelled the "forward guidance puzzle," which has also been the subject of academic debate.8 In Japan's case, analysis of recent developments shows that inflation expectations are susceptible to "negative price shocks."9 When actual inflation decreased from summer 2014 due mainly to the substantial decline in crude oil prices, inflation expectations -- which had been increasing steadily until then -- were negatively affected, first flattening out and then turning weaker. Especially in the case of Marco Del Negro, Marc Giannoni, and Christina Patterson, "The Forward Guidance Puzzle," Federal Reserve Bank of New York Staff Reports, no. 574 (2015); and Alisdair McKay, Emi Nakamura, and Jón Steinsson, "The Power of Forward Guidance Revisited," The American Economic Review, vol. 106, no. 10 (2016): 3133-3158. Bank of Japan, "Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE)" (2016); and Kousuke Nishino, Hiroki Yamamoto, Jun Kitahara, and Takashi Nagahata, "Supplementary Paper Series for the 'Comprehensive Assessment' (1): Developments in Inflation Expectations over the Three Years since the Introduction of Quantitative and Qualitative Monetary Easing (QQE)," Bank of Japan Review Series, no. 16-E-13 (2016). Japan, where inflation expectations are not anchored at the inflation target, inflation expectation formation is largely adaptive in that it is greatly affected by past inflation rates. As a result, inflation expectations do not respond instantaneously to central bank forward guidance. It is not easy to quickly dispel the deflationary mindset that has formed over the course of 15 years of deflation. However, as the first observation I mentioned shows, in line with theory, the Bank can work on inflation expectations through forward guidance, if it can avoid negative price shocks. Therefore, I think that the Bank's strong stance and persistent efforts toward achieving the price stability target of 2 percent are important. B. Determining the Optimal Yield Curve The second challenge that has emerged during the course of QQE is how to determine the optimal shape of the yield curve to achieve the 2 percent price stability target. In the world of conventional monetary policy, many benchmarks to determine the desirable short-term interest rate level have been devised. For instance, the relative level of the natural rate of interest and real short-term interest rates is important for assessing the degree of monetary easing, while the Taylor rule is an attempt to directly measure the desirable short-term policy interest rate. Under QQE, it is necessary to extend these approaches from short-term interest rates to the entire yield curve to establish new criteria for judgment. The Bank of Japan has started to work on both theoretical and empirical approaches to do so in the form of developing the concept of, and measuring, the "natural yield curve." Although research is still ongoing, we would like to continue to discuss the findings with academics and practitioners.10 Moreover, one point to consider when thinking about the optimal yield curve is that the effect of a decrease in interest rates varies depending on the maturity of interest rates in question. For instance, it is generally thought that reductions in short- to medium-term interest rates have the largest impact on economic activity and prices. The reason is that most corporate and Kei Imakubo, Haruki Kojima, and Jouchi Nakajima, "The Natural Yield Curve: Its Concept and Measurement," Bank of Japan Working Paper Series, no. 15-E-5 (2015). household financing is based on short- to medium-term interest rates. On the other hand, longer-term interest rates are likely to be more relevant for society's financial infrastructure functions such as insurance and pensions. An excessive decline in long-term and super-long-term interest rates may give rise to concerns about the rates of return on insurance and pension products, which may have a negative impact on the economy through a deterioration in people's sentiment. Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the "reversal rate."11 This refers to the possibility that if the central bank lowers interest rates too far, the banking sector's capital constraint tightens through the decline in net interest margins, impairing financial institutions' intermediation function, so that the effects of monetary easing on the economy reverses and becomes contractionary. In Japan's case, financial institutions have a solid capital base and credit costs have fallen sharply, so that at present their financial intermediation function is not impaired. However, because the impact of the low interest rate environment on financial institutions' soundness is cumulative, the Bank will continue to pay attention to this risk as well. Trying to determine the optimal shape of the yield curve gives rise to various theoretical and practical issues. This requires using the full range of functions of a central bank, which can broadly monitor not only the economic and price situation, but also the situation in financial institutions and financial markets. Taking also various kinds of qualitative information into account, the Bank of Japan will continue to pursue the shape of the yield curve that is deemed most appropriate in order to maintain the momentum toward the 2 percent price stability target. Conclusion As we are almost running out of time, I would like to conclude my speech. Since its introduction in 2013, QQE has been called a "new phase of monetary easing" as it is more powerful than any previous policies. If the term "new phase" is used, however, in the sense that the Bank embarked on the monetary easing measures imprudently and recklessly without any consideration for theory, I would like to emphasize that that is not the case. Markus K. Brunnermeier and Yann Koby, "The Reversal Interest Rate: An Effective Lower Bound on Monetary Policy," mimeo (2017). Needless to say, theory and practice are not opposites but complements that enhance each other. The famous expression "nothing is as practical as a good theory" applies to the theory and practice of monetary policy as well.12 Central banks, as policy authorities, need to put monetary policies into practice, but at the same time, these policies always have to be firmly supported by theory, since the effects and outcomes have a large impact on the economy and society. For example, the inflation-overshooting commitment is more powerful than any previous forward guidance and is unprecedented; yet, at the same time it is firmly grounded in economic theories regarding inflation expectation formation developed in recent years. On the other hand, because central banks confront a constantly changing world, in practice, they often face difficulties that cannot be explained by existing theories. When the Bank introduced large-scale JGB purchases and yield curve control, it took the limitations and issues suggested by theory into account, carefully investigated the merits and demerits of addressing those issues, and arrived at the current policy framework. I believe that such new steps in practice eventually will lead to new theoretical developments in the future. Although there remain issues to be resolved to achieve the price stability target of 2 percent, the environment surrounding prices in Japan has improved steadily compared to five years ago. I am convinced that this shows that the Bank's efforts based on the economic theories underpinning QQE have been going in the right direction. Going forward, with the output gap improving steadily, firms' stance is likely to gradually shift toward raising wages and prices. If further price rises come to be widespread, inflation expectations are likely to rise steadily. The Bank will continue to persist with powerful monetary easing to ensure that such positive developments are not cut short. Thank you for your attention. Kurt Lewin, "The Research Center for Group Dynamics at Massachusetts Institute of Technology," Sociometry, vol. 8, no. 2 (1945): 126-136. Quantitative and Qualitative Monetary Easing and Economic Theory Speech at the University of Zurich in Switzerland November 13, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Consumer Prices and Policy Interest Rates % CPI (all items less fresh food) Policy interest rates -1 -2 -3 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 17 Notes: 1. The CPI figures (y/y % chg.) are adjusted for changes in the consumption tax rate. 2. For the period when no target interest rate was adopted, figures for the policy rate are the interest rate applied on excess reserves. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 2 Potential Growth Rate y/y % chg. Total factor productivity Capital input Labor input Potential growth rate -1 -2 FY 85 Note: Based on BOJ staff estimations. Figures for the first half of fiscal 2017 are those for 2017/Q2. Source: Bank of Japan. Chart 3 Monetary Policy Responses and Developments in Real GDP after the Global Financial Crisis Real GDP Policy Interest Rates % s.a., 2008/Q2=100 Japan United States Euro area United Kingdom Japan -1 CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 United States Euro area United Kingdom CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Note: For Japan, for the period when no target interest rate was adopted, figures for the policy rate are the interest rate applied on excess reserves. Sources: Bank of Japan; Federal Reserve; European Central Bank; Bank of England; Cabinet Office; Haver. Chart 4 Central Bank Assets % of nominal GDP Japan United States Euro area CY 95 Note: Figures for Japan and the euro area for 2017/Q3 are calculated using their nominal GDP figures for 2017/Q2. Sources: Bank of Japan; Federal Reserve; European Central Bank, etc. Chart 5 Natural Rate of Interest and Real Interest Rate % Natural rate of interest Real interest rate -1 -2 CY 95 Note: Based on BOJ staff estimations using 10-year JGB yields, etc. For details of the estimation procedures of the natural rate of interest, see Kei Imakubo et al., "The Natural Yield Curve: Its Concept and Measurement," Bank of Japan Working Paper Series, no.15-E-5 (2015). The shaded area indicates the 95 percent confidence interval for the natural rate of interest. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bloomberg; Bank of Japan, etc. Chart 6 Japan's Economy Corporate Profits Output Gap and Prices y/y % chg. % -2 -1 Unemployment Rate s.a., % 6.0 s.a., % Unemployment rate -4 5.0 4.5 4.0 3.5 3.0 2.5 -2 -6 -8 5.5 Ratio of current profits to sales (all industries and enterprises) -3 Output gap (left scale) -4 CPI (all items less fresh food and energy, right scale) -10 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 -5 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 2.0 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. The output gap is based on BOJ staff estimations. 2. The CPI figures are adjusted for changes in the consumption tax rate. 3. Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Sources: Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Finance. Chart 7 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 8 Inflation Expectations 2.5 y/y, ann. avg., % Economists (6 to 10 years ahead) Firms (5 years ahead) 2.0 Households (Over the next 5 years) 1.5 1.0 0.5 0.0 CY 05 Notes: 1. Figures for firms are those for "Outlook for General Prices" in the Tankan survey (all industries and enterprises, average). 2. Figures for households are from the Opinion Survey on the General Public's Views and Behavior, estimated using the modified Carlson-Parkin method. Sources: Bank of Japan; Consensus Economics Inc., "Consensus Forecasts."
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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, Miyazaki, 8 November 2017.
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November 8, 2017 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Miyazaki 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 overseas economies. Business sentiment of manufacturing firms has been on an improving trend on a global basis, and the world trade volume has been recovering. In this situation, overseas economies have continued to grow at a moderate pace on the whole. In terms of the outlook, overseas economies are expected to continue growing at a moderate pace. According to the World Economic Outlook, released in October 2017 by the International Monetary Fund, the global growth rate is projected to be 3.6 percent in 2017 and 3.7 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 also has continued to recover steadily. As for the outlook, the economy will likely follow a moderate recovery trend, while uncertainty -- associated, for example, with political issues such as those regarding negotiations on the United Kingdom's exit from the European Union (EU) -- is expected to be a burden. The Chinese economy has continued to see stable growth on the whole, partly due to the effects of authorities' measures to support economic activity. As for the outlook, the economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Emerging economies other than China and commodity-exporting economies have picked up on the whole. As for the outlook, their growth rates are likely to increase gradually, due mainly to the spread of the effects of steady growth in advanced economies and the effects of the economic stimulus measures. Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the U.S. economic policies and their impact on global financial markets, (2) developments in emerging and commodity-exporting economies, (3) negotiations on the United Kingdom's exit from the EU and their effects, (4) prospects regarding the European debt problem, and (5) geopolitical risks. I hold the view that it is important to stay vigilant regarding these risk factors, especially now that the growth rates of overseas economies are rising moderately. B. Japan's Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan. Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. The real GDP growth rate for the April-June quarter of 2017 was 0.6 percent on a quarter-on-quarter basis, representing positive growth for six consecutive quarters for the first time in about 11 years. The growth rate was above the potential growth rate, which is estimated to be in the range of 0.5-1.0 percent.1 With regard to the outlook, Japan's economy is likely to continue its moderate expansion. Through fiscal 2018, 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 continue their moderate increasing trend on the back of growth in overseas economies. In fiscal 2019, the economy is expected to continue expanding, supported by external demand, although the growth pace is projected to decelerate due to a slowdown in domestic demand.2 According to the October 2017 Outlook for Economic Activity and Prices (hereafter the Outlook Report), released by the Bank of Japan, the medians of the Policy Board members' Under a specific methodology, Japan's potential growth rate is estimated to be in the range of 0.5-1.0 percent. 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. It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers. forecasts of the economic growth rate are 1.9 percent for fiscal 2017, 1.4 percent for fiscal 2018, and 0.7 percent for fiscal 2019. 2. Prices Let me now explain price developments. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food has been accelerating and is in the range of 0.5-1.0 percent, while the rate of change for all items less fresh food and energy has remained slightly positive. With regard to the outlook, the year-on-year rate of change in the CPI (all items less fresh food) is likely to continue on an uptrend, mainly on the back of the improvement in the output gap and the rise in medium- to long-term inflation expectations. The rate will likely reach around 2 percent in around fiscal 2019. 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 October 2017 Outlook Report are 0.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and, excluding the direct effects of the scheduled consumption tax hike, 1.8 percent for fiscal 2019.3 II. Characteristics of Japan's Economy and Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I would like to outline my understanding of the characteristics of the recent developments in Japan's economy and then discuss several points that I think deserve particular attention in terms of realizing the outlook for economic activity and prices that I mentioned earlier. The consumption tax hike scheduled to take place in October 2019 -- to 10 percent -- and the reduced tax rate to be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers are incorporated in the forecasts, but individual Policy Board members make their forecasts of the CPI based on figures excluding the direct effects of the consumption tax hike. The forecasts for the CPI for fiscal 2019 that incorporate the direct effects of the consumption tax hike are constructed as follows. First, the contribution to prices from the tax hike is mechanically computed on the assumption that the tax increase will be fully passed on for taxable items. The CPI will be pushed up by 0.5 percentage point. Second, this figure is added to the forecasts made by the Policy Board members. A. Characteristics of the Recent Developments in Japan's Economy One of the characteristics of the recent developments in Japan's economy is how the economic growth has been led by various components in a well-balanced manner. In terms of external demand, exports have been on an increasing trend, with overseas economies continuing to grow at a moderate pace. For domestic private demand, business fixed investment has been on a moderate increasing trend, with corporate profits and business sentiment improving, and private consumption has increased its resilience against the background of steady improvement in the employment and income situation. Regarding public demand, public investment also has been increasing as the positive effects resulting from the set of stimulus measures formulated in fiscal 2016 became evident. The recent environment in which multiple components of the economy are contributing to its overall expansion in a well-balanced manner is necessary for Japan's economy to continue expanding moderately. I consider that such environment is especially important in the operation of the virtuous cycle from income to spending and the functioning of the mechanism in which inflation rises moderately accompanied by wage increases. B. Employment and Income Situation Let me now talk about the employment and income situation as one of the factors to consider in assessing the outlook for economic activity and prices. Supply-demand conditions in the labor market have continued to tighten steadily. The active job openings-to-applicants ratio -- which has followed a steady uptrend -- has been at a high level last seen in the first half of the 1970s, as the rate of increase in the number of employees has continued to show growth of around 1.5 percent. Moreover, the unemployment rate has been in the range of 2.5-3.0 percent recently and a perception of labor shortage has heightened. It is expected that the number of employees will keep increasing and that the supply-demand conditions in the labor market will tighten further. On the wage side, total cash earnings per employee have risen moderately, albeit with some fluctuations. The year-on-year rate of increase in hourly scheduled cash earnings of part-time employees, which are responsive to supply-demand conditions in the labor market, recently registered relatively high growth of around 2.5 percent. With regard to the outlook, the pace of increase in full-time employees' cash earnings is expected to accelerate moderately, with that in base pay accelerating as the rise in inflation expectations becomes more evident. In light of such employment and wage conditions, employee income has increased moderately, albeit with fluctuations. Going forward, it is likely to increase at a moderate pace, but with differences in wage-setting mechanisms between full-time and part-time employees, there is a risk that firms will remain cautious with their decisions on wage setting. In this context, I am paying attention to firms' stance regarding wages going forward. C. Prices Next, I will discuss the output gap and inflation expectations, which are the main factors that determine inflation rates. First, the output gap has improved steadily, being in the range of 1.0-1.5 percent in the April-June quarter of 2017. Considering the improvements seen in various indexes, the output gap likely will have expanded somewhat within positive territory in the July-September quarter. With regard to the outlook, it is projected to widen further within such territory in fiscal 2017; thereafter, it is projected to continue expanding moderately within positive territory both on the capital and labor sides, reflecting the increase in demand at home and abroad. In the second half of fiscal 2019, although such expansion is likely to pause due to the effects of the scheduled consumption tax hike, the output gap is expected to remain substantially positive. Second, medium- to long-term inflation expectations have remained in a weakening phase. As for the outlook, they are likely to follow an increasing trend on the back of the following: (1) in terms of the adaptive expectation formation mechanism, firms' stance is likely to gradually shift toward raising wages and prices with the improvement in the output gap, and (2) in terms of the forward-looking expectation formation mechanism, the Bank will pursue monetary easing through its strong commitment to achieving the price stability target. I would note that attention needs to be paid to the possibility that, depending on the developments in firms' price-setting stance, there might be items for which prices are not particularly responsive to the output gap and the rise in inflation expectations might be delayed. III. Conduct of Monetary Policy Let me now turn to the Bank's monetary policy. The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and has been conducting monetary policy to achieve this target at the earliest possible time. There are three reasons why the Bank is aiming at 2 percent inflation. The first is a bias in price statistics. Since the CPI has a statistical tendency of demonstrating a higher inflation rate than the actual one, a sufficiently high inflation rate is necessary in order to ensure price stability. The second reason is with regard to securing policy room for the future. The level of nominal interest rates is usually determined in accordance with that of inflation rates. With a high level of nominal interest rates, the Bank will have more room for a monetary policy response by being able to push down the policy interest rates to stimulate the economy at times of economic downturns. The third reason is that the 2 percent target is a global standard. Central banks in major economies are currently conducting monetary policy with the aim of achieving around 2 percent inflation. For this reason, it is considered that the Bank's aim of achieving 2 percent inflation will lead to stable foreign exchange rates in the long run and also contribute to the stability of corporate activities. What is important here is that the Bank conducts monetary policy based on the principle that the policy shall aim at "achieving price stability, thereby contributing to the sound development of the national economy," as stipulated in the Bank of Japan Act. The Bank is not simply trying to achieve a rise in prices, but it is aiming for an economy with a virtuous cycle in which the incomes of people increase firmly as the price stability target of 2 percent is achieved. If prices rise in a stable manner and firms and households start to behave based on this assumption, prices of goods and services will rise, which in turn will increase firms' sales and profits. With such increases, wages would rise accordingly, leading to more active consumption. The Bank is aiming to achieve a sustainable price stability in which such an economic virtuous cycle operates. With a view to achieving the price stability target, the Bank introduced Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control in September 2016, and has been implementing powerful monetary easing policy under this framework. This policy framework 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, according to the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. 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. Currently, the momentum toward achieving the price stability target of 2 percent is being maintained firmly, and the year-on-year rate of change in the CPI is expected to increase toward 2 percent. Nevertheless, there is still a long way to go to achieve the target. 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 persistently 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 for Japan's economy from a longer-term perspective. According to the Bank's estimates, the potential growth rate, which was about 4 percent in the latter half of the 1980s, has been in the range of 0.5-1.0 percent recently. It can be said that the rate -- although it has been on an increasing trend in recent years -- has been trending downward over the long term, mainly reflecting the population decline and low productivity growth. This has led to a decline in growth expectations in Japan, engendering some pessimistic views on the prospects for the economy. Although it is true that the population decline has a large impact on the economy and that productivity improvement takes time, I consider it unnecessary to underestimate the potential of Japan's economy; my view is that it is possible to boost the potential growth rate. Let me add that raising the potential growth rate is also important as the Bank aims for sustainable price stability, and efforts by a wide range of entities are necessary to this end. To raise the potential growth rate of the economy, from the viewpoint of the management of firms, they not only need to streamline or upgrade their supply systems, but also explore new demand and arrange their supply systems in a way that would match such demand, given that we are in a time when consumers' demand varies and constantly changes. In other words, it is necessary for firms to tap potential demand and work on product innovation -which aims to develop and provide new products that are unique and have high value-added -- over the long term in a sustainable manner. To this end, I believe that two factors are especially important: personnel who can develop new products, and an environment in which such products are desired. Needless to say, it is necessary to acquire personnel who are capable of producing and implementing new ideas to generate innovations, regardless of their scale -- that is, innovations ranging from paradigm-shifting developments to refinements to existing products. Let me also highlight the importance of an environment in which new products are desired. In order for a number of innovations to be created in Japan, it is essential to maintain the virtuous cycle between demand and innovation by appropriately stimulating demand. It is said that necessity is the mother of invention. In other words, innovation is unlikely to occur when not many consumers seek products that outperform existing ones. Having said that, the current situation, in which the Bank's accommodative monetary policy is appropriately stimulating demand, is likely having a positive impact in terms of bringing about innovation. Of course, it takes time to tap potential demand and transform this into actual demand. Therefore, I believe it is important to persistently maintain accommodative financial conditions with a view to accelerating innovation. Thank you for your attention.
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 Annual General Meeting of the Asia Securities Forum, Tokyo, 28 November 2017.
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November 28, 2017 Bank of Japan Asian Financial Markets -- 20 Years since the Asian Financial Crisis, and Prospects for the Next 20 Years -Keynote Speech at 2017 Annual General Meeting of Asia Securities Forum in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction: The Past 20 Years Good morning ladies and gentlemen. It is my great pleasure to join you this morning at the Annual General Meeting of Asia Securities Forum. The year 2017 marks twenty years since the Asian Financial Crisis. Before the crisis, the region was highly praised for its strong economic growth. But at the same time, weaknesses had been accumulating, such as large current account deficits, high external debt, and massive non-performing loans. When a combination of economic, financial, and corporate problems triggered a sharp loss of confidence and capital outflows from the region, the crisis erupted and countries faced extreme recessions. Twenty years later, Asia is now the largest contributor to global growth, accounting for 57 percent of global growth in real terms for 2016.1 Domestic demand, especially consumption, has become the engine of growth and major cities in the region have prospered, being often characterized by the simple phrase, "lively and vibrant." Here in Tokyo, the surging number of Asian tourists to Japan is itself evidence for the strength of growing consumption in Asia. I cannot but think of the significant changes that the economies of Asia, including Japan, have experienced over the past twenty years. These changes have been made possible through countless painstaking efforts, initiatives, and policies that countries in the region have introduced, both individually and collectively. I myself have been at the forefront of policy making in orchestrating crisis responses and enhancing regional cooperation in Asia for almost two decades, at Japan's Ministry of Finance, the Asian Development Bank (ADB), and the Bank of Japan (BOJ). Confirmation of the region's greater resilience against a major economic shock is deeply reassuring. Let me touch upon the responses taken in the region after the crisis two decades ago. First, Asian countries improved their current account balances and strengthened foreign exchange reserves. The increase in net external assets has enhanced resilience against possible capital outflows. Second, the ratio of non-performing loans has decreased, and regulatory and The percentage share is based on real GDP (constant 2010 U.S. dollars), taken from the World Bank's World Development Indicators. "Asia" in this context includes Asia & Pacific and South Asia. supervisory frameworks have been strengthened. Third, many countries in the region have adopted more flexible exchange systems. Last but not least, financial markets, especially local currency bond markets, have continued to develop. The development of local currency bond markets was aimed at addressing two issues. One was the so-called double mismatches, that is, currency mismatches and maturity mismatches, and the other was a bank-centric financial system. Financial institutions in the region were borrowing short-term debt in dollars to finance longer-term lending in domestic currencies. This double mismatch was particularly damaging as the significant depreciation of their currencies inflated borrowers' debt burden. This led foreign lenders to refuse rolling short-term debt, which then triggered massive defaults of banks and firms. Twenty years later, the degree of the double mismatches has been reduced. Local currency bond markets have grown, as can be seen in Chart 1, providing an alternative intermediation channel to bank-financing. Today, the capitalization of Asian local bond markets is equivalent to 3.7 trillion U.S. dollars, more than 100 times larger than before the crisis. 2 We have certainly made progress. Economies have become more resilient to exogenous shocks, and the financial sector has developed significantly. In addition to these individual efforts, various initiatives have been established through regional cooperation. For example, a regional financial safety net, the Chiang-Mai Initiative Multilateralization, has been set up by the ASEAN countries, together with China, Japan, and Korea, or ASEAN+3. The Asian Bond Market Initiative (ABMI) was launched in 2002 by ASEAN+3, and this has contributed to the development of local currency bond markets. Market associations and self-regulatory organizations, such as yourselves, have also played an important part in enhancing the efficiency and transparency of the markets. The total is as of June 2017 and covers nine countries and regions, including China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Thailand, and Vietnam. The scaling factor compares June 2017 with June 1997 with reference to comparable four countries and regions, including China, Hong Kong, Korea, and Thailand. Data are taken from Asian Bonds Online. Challenges Remaining However, important challenges still remain. Today, I will focus on the importance of further developing local currency bond markets, partly because I am surrounded here by people from the securities industry. As I have mentioned, local currency bond markets have grown over the last twenty years. At the same time, bank financing still dominates as a primary source of funding in the region. You can see this from Chart 2. Bank credit, as a source of corporate funding, has outgrown both stock market capitalization and corporate bonds outstanding over the years. The strong reliance on bank-financing may be explained by Asian corporate culture, which puts high priority on business relationships. Bond financing is often not the first choice for domestic firms when financing their business. To make my point clear, I am not proposing that Asian corporates should rely on market-financing over bank-financing, as is the case in some other countries. I would rather like to stress the importance of diversifying the sources of funding to reduce the direct effect on the corporate sector, should the banking sector face economic or financial shocks. Along with this cultural issue, domestic firms are deterred by the cost of bond-financing when compared with bank loans. One of the factors that explain the unattractiveness of bond-financing may be the lower levels of market activity and less liquidity in the secondary market. With lower liquidity in the secondary market, investors require additional premiums, which increase the cost of issuance. In such an environment, domestic firms are more likely to rely on banks for financing. In this regard, developing highly efficient and liquid local currency bond markets is essential. Past initiatives in the region have enriched the primary markets. We may therefore need to put more focus on developing liquid secondary markets. As presented in Chart 3, according to a survey conducted by Asian Bonds Online, there is no single factor that inhibits the development of the secondary markets. Survey respondents were asked how important each of the eight structural issues was, with respect to local currency bond market liquidity. The survey results in recent three years show that "Greater Diversity of Investor Profile" was the most important structural issue for promoting the market liquidity. Another structural issue, "Transaction Funding," which also marked a relatively high score, may also be worth noting as an important impediment. Let me elaborate these two structural issues. First, the issue of investor base diversification. Since banks are the dominant financial institutions in the region, they are often the largest investor group as well. The presence of buy-and-trade investors like mutual funds, and active investors like hedge funds is relatively low, and this may be one of the causes of low liquidity in the secondary market. But it has to be borne in mind that merely increasing the size of the domestic investor base does not necessarily improve market functioning. In the region, demand for local currency bonds exceeds supply. In this situation, if a few dominant buy-and-hold type investors become even larger, they may take bonds out of circulation, leaving fewer investable bonds in the market. It is therefore important to increase the variety of investor types, attracting those who have different investment objectives and strategies. The second issue is that of transaction financing. Improving it would require the development of repo markets. Repo markets are a key instrument for banks to trade cash while controlling counterparty risks. A well-functioning repo market is also a precondition for feasible market-making by dealers, and would increase two-way trading in both equity and bond markets. However, repo transactions in many Asian emerging markets are still restricted or small in transaction volume, as uncollateralized short-term funding conditions are easy and many investors do not have the incentive to use such instruments. I have discussed the importance of developing local currency bond markets from the viewpoint of preparing for exogenous shocks and adverse circumstances. I would like to add another perspective related to the main theme of this meeting, "Ways for building a sustainable future." It has often been said that, in order to achieve sustainable growth, the region must narrow its large infrastructure gaps. The ADB estimates that this will require funding of over 1.7 trillion U.S. dollars a year, through 2030.3 This magnitude of financing is well beyond the current funding capabilities of individual national governments, international organizations, and banks that operate as project finance lenders in the region. In the financing of infrastructure assets, bond finance offers a number of advantages over bank loan finance. Infrastructure assets often generate stable long-term cash flows that make infrastructure debt an attractive investment opportunity for bond investors. Insurers and pension funds who have long-dated liabilities are seeking to match them with long-dated assets. Bond markets are able to provide opportunities to issue longer-tenor debt at fixed interest rates, thereby reducing the risks associated with refinancing shorter-tenor debt and the necessity of having to enter into long-term interest rate swaps to manage the risk of interest rate fluctuation. Also, as revenues from most infrastructure projects are denominated in local currencies, local currency infrastructure bonds will be able to mitigate the risk of currency mismatch. Central Banks' Initiatives Let me now explain some measures taken by central banks in the region. Along with the Ministries of Finance, central banks of ASEAN+3 are taking part in the ABMI that I mentioned earlier, and have contributed especially to the discussion of cross-border payment and settlement issues. Furthermore, the Executives' Meeting of East Asia Pacific (EMEAP) central banks, a group of 11 central banks and monetary authorities in the East Asia and Pacific region, set up the Asian Bond Fund (ABF) initiative in 2003, in order to develop local currency bond markets. The region has seen several advancements since the launch of the ABF initiative. They include (1) accelerated tax reforms to exempt nonresident investors from withholding tax, enhancement of the regulatory framework for exchange-traded funds, (3) liberalization of foreign exchange administration rules, (4) improvements in regional market infrastructure, and (5) the adoption of documentation in line with international best practices. These ADB (2017), Meeting Asia's Infrastructure Needs. advancements could perhaps have been achieved sooner or later without the ABF initiative, but the initiative certainly had a positive effect in facilitating these developments.4 The EMEAP central banks have also been engaged in promoting analysis of financial market developments in the region. In 2014, EMEAP published a report that assessed the developments and challenges in the repo markets in the region.5 In addition to the benefits of efficient repo markets that have been noted, repos are an essential instrument in the open market operations of central banks, and therefore important to the transmission of monetary policy. The deeper these markets are, the more scope they offer central banks in their liquidity management operations. Along with intra-regional initiatives, individual central banks have also introduced measures aimed at facilitating repo transactions. For example, the Monetary Authority of Singapore launched the Securities Repo Facility to promote their market-making activities. The central banks in Malaysia, Thailand, and Indonesia, have set up programs to increase awareness of repo markets among market participants, including corporate treasuries. Many other central banks are also working with investors, issuers, and intermediaries, to assess what can be done to facilitate active repo markets. We, at the BOJ, have been participating in discussions at EMEAP to enhance the ABF initiative, and have been active in conducting market reviews. Assistant Governor Maeda of the BOJ currently chairs the Working Group on Financial Markets, leading further work in this area. The Bank also contributes to capacity-building with other authorities. Concluding Remarks: Initiatives for the Next 20 Years I have discussed the importance of developing local currency bond markets, its remaining challenges, and initiatives taken by central banks in the region. Let me now summarize some For example, see Mizen, P., and Tsoukas, S. (2014), "What Promotes Greater Use of the Corporate Bond Market? A Study of the Issuance Behaviour of Firms in Asia," Oxford Economic Papers, Vol. 66 (1), pp. 227-253. EMEAP Repo Markets: State of Play -- A Report by the EMEAP Working Group on Financial Markets 2014 (available from http://www.emeap.org/index.php/publications/). of the wide range of benefits that can be gained by developing deep and liquid local currency bond markets. First, it makes possible for governments and firms to borrow in local currencies at longer maturities. This will reduce the risks associated with currency and maturity mismatches. Second, the development of such bond markets will enable borrowers to diversify their sources of funding by complementing bank-financing. At the same time, investors will gain more investment opportunities. With enhanced investment opportunities, abundant savings in the region could be recycled within the region. It could also fill part of the large infrastructure funding gap. Lastly, well-functioning primary and secondary bond markets reinforced by an expanded investor base will improve the overall efficiency of financial markets, which in turn will aid macro-economic policy implementation. Over the past two decades, there have been many fruitful initiatives and programs to develop local currency bond markets. However, this is still work in progress and more needs to be done. As the market is a place of interaction, all stakeholders must play their roles. A successful implementation strategy must identify critical paths and appropriate sequencing to achieve the optimal result. Cooperation among authorities and private market participants is the key to further development. The ASEAN+3 Bond Market Forum (ABMF) was set up in September 2010 by the ASEAN+3 countries as a common platform to foster standardization of market practices and harmonization of regulations related to cross-border bond transactions in the region. Members comprise experts drawn from both public and private sector organizations, such as those present at this forum today. This type of forum is a practical step toward achieving the ultimate common goal of Asia's bond market development. The global economy continues to recover and the financial system has been maintaining stability. As the IMF's Managing Director expressed in her Global Policy Agenda at the last International Monetary and Financial Committee (IMFC) meeting, current economic and financial conditions provide "a window of opportunity" to tackle key challenges. Stakeholders in the region must maintain the will to further develop and deepen the market. Through these concerted efforts, the challenges in fostering bond markets can be overcome. On the 10th anniversary of the Asian Financial Crisis, at a BOJ symposium, the then Governor Zeti of Bank Negara Malaysia, stated: Asia, especially the ASEAN tigers, is back and poised to leap on to the next wave of economic advancement and prosperity. 6 How correct she was. Asia's economy has developed much more vigorously than many had anticipated. Economic integration in the region has further deepened through the development of global value chains. Looking ahead to the next twenty years, Asia's economy will continue to be at the core of world economic growth and we will experience further integration. Along with such developments, it is natural to seek more developed and integrated regional financial markets. We can anticipate that twenty years from now, Asia's financial markets will have developed to become as efficient and liquid as other major financial centers in the world. Thank you for your kind attention. "Ten Years after the Asian Currency Crisis: Future Challenges for Asian Economies and Financial Markets," a speech at the international symposium hosted by the Center for Monetary Cooperation in Asia (CeMCoA) of the BOJ on January 22, 2007 in Tokyo (available from https://www.boj.or.jp/en/announcements/release_2007/index.htm/). Asian Financial Markets － 20 Years since the Asian Financial Crisis, and Prospects for the Next 20 Years － November 28, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Increased Resilience Less reliance on foreign-currencydenominated short-term funding % Growth of Asian local currency bond markets US$ trillion Indonesia Malaysia Philippines Thailand Corporate Government CY Notes : 1. The figures are the ratios of foreign currency-denominated short-term claims to all claims of foreign banks. 2. The latest data are as of end-June 2017. Source: BIS. CY Notes: 1. Aggregates of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam. 2. The figures for 2017 are as of end-June 2017. Source: Asian Bonds Online. Chart 2 Bank-Dominated Financial Systems Corporate financing in Emerging Asia US$ trillion % of GDP Local currency bonds Stocks (market cap.) Investor base in Emerging Asia Bank credit Pension funds Insurance Mutual funds Deposit money banks Note: Emerging Asia is the aggregate of China, India, Indonesia, Korea, Malaysia, Philippines, Thailand, and Vietnam. Sources: Asian Bonds Online; The World Bank, World Development Indicators. Notes: 1. As of end-2013 except for India’s deposit-money-banks figure which refers to end-March 2014. 2. Figures for Pension funds and Mutual funds for Indonesia and Vietnam, and Insurance for Hong Kong are not available. Sources: The IMF, International Financial Statistics; National central banks; The World Bank, Global Financial Development Database. Chart 3 Structural Issues in Local Currency Corporate Bond Markets in Emerging East Asia Annual Bond Market Liquidity Survey more important 3.3 3.2 3.0 2.9 2.9 Transaction funding FX regulations 2.7 2.7 3.0 less important Greater Transparency diversity of investor profile Hedging mechanisms Settlement & custody Tax treatment Market access Notes: 1. Emerging East Asia comprises China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam. 2. Averages of four scores answered (1: not important, 2: somewhat important, 3: important, 4: very important) in 2015-2017. Source: Asian Bonds Online.
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Kin'yu Konwa Kai (Financial Discussion Meeting), hosted by the Jiji Press, Tokyo, 29 November 2017.
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November 29, 2017 Bank of Japan New Frontier of Macroprudential Policy: Addressing Financial Institutions' Low Profitability and Intensified Competition Speech at the Kin'yu Konwa Kai (Financial Discussion Meeting) Hosted by the Jiji Press Hiroshi Nakaso Deputy Governor of the Bank of Japan I. Introduction Japan's financial crisis was reaching its climax 20 years ago in 1997. In November of that year, four financial institutions, including a major one, failed in succession in a single month, a period later referred to as Dark November.1 I clearly remember that this was when Japan's financial system was on the verge of a meltdown. Since the comprehensive safety net for financial system stability was underdeveloped at that time, which is not the case today, the Bank of Japan bore the heavy load of taking measures to stabilize the financial system, including the so-called Tokuyu (special loans). While we barely managed to avert a financial meltdown, the Bank suffered credit losses of about 200 billion yen from the Tokuyu. Following this painful experience of the bursting of the bubble in the 1990s, Japan's safety net has developed greatly, and it now protects financial system stability against failures of not only deposit-taking financial institutions but also securities companies, insurance companies, and financial holding companies. Thus, in Japan, crisis management tools have been expanded based on the lessons learned during the financial crisis. At the same time, the importance of having a policy to prevent a financial crisis from materializing by detecting the accumulation of financial imbalances became recognized. In order to maintain the stability of the financial system, it is not necessarily sufficient to adopt measures based on the microprudential perspective of identifying risks borne by individual financial institutions and encouraging improvement in their business activities. It is also important to take measures based on the macroprudential perspective of assessing risks of the whole financial system with due consideration to the interconnectedness of the real economy, financial markets, and behavior of financial institutions. Such importance of macroprudential policy became widely recognized around the globe when the global financial crisis jolted the world economy 10 years after Japan's financial crisis. Today, I will talk about macroprudential policy and its challenges while touching on the Bank's experiences thus far and the recent situation of Japanese financial institutions. Financial crises do not always emerge in the same form. Thus, we should bear in mind that signs of financial crises will lurk in various forms depending on economic and financial In November 1997, four financial institutions -- namely, Sanyo Securities, Hokkaido Takushoku Bank, Yamaichi Securities, and Tokuyo City Bank -- went bankrupt in succession. conditions of the time. It is important to accurately assess such potential vulnerabilities of the financial system from a macroprudential perspective and take appropriate policy measures. Even if these measures are extraordinary or unconventional based on historical standards, the Bank should take these measures when necessary to ensure financial system stability. At present, Japan's financial system is maintaining stability, but I think that attention should be paid to the potential vulnerabilities. That is what I will talk about today; more specifically, the problem of financial institutions' low profitability and intensified competition, with a main focus on regional financial institutions. This problem is closely related to Japan's structural problems, such as a decline in population and the number of firms, and it is a phenomenon that advanced economies have never experienced before (Chart 1). In this sense, the impact of financial institutions' low profitability and intensified competition arising from the decline in population and the number of firms is a financial vulnerability that takes a totally different form from the past. Regional financial institutions need to appropriately address this issue in order to continue to play an important role in supporting the regional economy. The Bank also has to explore a new frontier of prudential policy by itself. II. Assessment of Systemic Risk Before going into a detailed explanation about the potential vulnerabilities of Japan's financial system, let me first talk about macroprudential policy. If the financial cycle becomes large in magnitude or many financial institutions become more interconnected by increasing common exposure or forming mutual asset-liability arrangements, systemic risk will emerge and spread within the financial system. The objective of macroprudential policy is to strengthen the resilience of the financial system and contain systemic risk. In order to implement macroprudential policy, we first need to assess systemic risk. Specifically, the assessment is composed of two main parts. The first is to assess the financial cycle. We examine whether the current conditions are in an expansion phase or a contraction phase of the cycle, considering the outlook. The second is to identify sources of systemic risk, or potential financial vulnerabilities, and to diagnose the financial system's resilience to the stress. For example, we conduct stress testing to assess whether financial institutions have sufficient capital and liquidity under stress events. Assessment of Financial Cycle and Results of Stress Testing The Bank publishes the Financial System Report (FSR) semiannually, with the objective of assessing systemic risk. Regarding the financial cycle that is the first part of the assessment, on the whole no imbalances in financial and economic activities can be observed while the funding conditions for firms and households have been highly accommodative. With banks' very active lending stances, the real estate market seems overheated in some areas; however, our aggregate financial cycle indicator estimated from major financial activity indexes has shown no significant imbalances recently (Chart 2).2 Moreover, with regard to the resilience of the financial system against the stress that concerns the second part of the assessment, the results of stress testing indicate that capital adequacy ratios at financial institutions remain above the regulatory requirements on the whole even when a tail event comparable to the Lehman shock occurs. While regional financial institutions have actively stepped up their risk taking in recent years by increasing their real estate loans and investments, the adverse shocks in the real estate markets seem to exert only a limited impact on the financial system from a macroprudential perspective, partly because real estate-related markets have not boomed as much as they did during the real estate boom from 2006 through 2007.3 In other words, as the peak of the current financial cycle is not high, even if the cycle starts to contract, the trough is unlikely to be deep. Also, even when the trough is as deep as the level observed during the Lehman shock, financial institutions maintain sufficient capital to Looking at Chart 2 in detail, during the bubble period in the late 1980s, the financial expansion had led to the economic expansion. In the early 1990s after the burst of the bubble, the financial contraction had caused the economic downturn. Afterward, the real economy went through several business cycles with short-lived recovery phases, as the balance sheet adjustment at firms and financial institutions continued; in other words, the financial cycle remained in a stagnation phase. Since the beginning of the 2000s, the adjustment of excess debt by firms and the disposal of nonperforming loans by banks have run their course and the financial cycle has entered into a recovery phase, and thus the economic recovery has lasted a long time. Later, the real economy deteriorated significantly due to the Lehman shock but recovered relatively quickly as no significant financial imbalances were accumulated. For details, see Chapter V in the April 2017 issue of the FSR. withstand that stress. Thus, there is no concern about large-scale systemic risk at present, and it can be judged that Japan's financial system has been maintaining stability. Warning from the Stock Market Nonetheless, there is no guarantee that the financial system can continue to maintain stability in the future. The stock market seems to send us a critical signal on this point. The expected default frequency (EDF) for financial institutions extracted from stock price movements has been rising recently, mainly for regional banks (Chart 3).4 The short-term EDF has been more or less unchanged, albeit with some fluctuations such as a temporary rise following the Bank's introduction of the negative interest rate policy in early 2016. Meanwhile, the medium- to long-term EDF has been following a moderate upward trend since even before the introduction of Quantitative and Qualitative Monetary Easing (QQE) in 2013 and the negative interest rate policy. So, will regional financial institutions give rise to systemic risk that poses threats to the stability of the financial system? In Japan, no regional financial institutions are designated as either Global Systemically Important Banks (G-SIBs) or Domestic Systemically Important Banks (D-SIBs). Although regional financial institutions are not individually systemic institutions, they can be "systemic as a herd" if many of them hold common exposure and show similar behavior. From a macroprudential perspective, it is important to look at regional financial institutions as a whole and pay attention to whether the similarity of individual financial institutions' behavior will lead to the emergence of systemic risk. Due to Japan's financial crisis in the 1990s, almost 180 small and medium-sized financial institutions including shinkin banks and credit cooperatives failed. Such financial institutions were not individually systemic institutions, but they held common risk exposure through the extension of real estate loans. Thus, as a failure of one bank reminded the people of a default risk of another bank, a systemic risk associated with a chain of bank runs was recognized. To avoid the materialization of such risk, the government set forth blanket guarantees for all forms of bank liabilities including deposits. Based on this, the Bank Moody's EDF is defined as a measure of the probability that the market value of a firm's assets will fall below its liabilities payable over a specified period of time, which is estimated based on a firm's stock price information. provided individual financial institutions that were on brink of bankruptcy with loans to maintain the stability of the financial system (the so-called Tokuyu).5 A key issue that these experiences raised about prudential policy is whether a future stress event will result in business instability of only the specific financial institution or in simultaneous (or a chain of) business instability of many financial institutions that hold common exposure. In the former case, a financial institution with business instability can be barred from the financial system. In the latter case, however, there is a concern that the impact will spread across the entire financial system and develop into systemic risk. The stock market sends us a critical signal on this point as well. The CoVaR, which is a widely used systemic risk indicator measured based on developments in the stock market capitalization of regional banks, has shown an upward trend recently against the background of the heightened comovement between the stresses faced by individual banks (Chart 4).6 Thus, the indicator extracted from the stock market implies the possibility that business conditions will become unstable simultaneously at many regional financial institutions that have common exposure. While the EDF and the systemic risk indicators have been rising, regional financial institutions have sufficient capital and liquidity at present. Thus, there are no immediate threats to the stability of the financial system. As I mentioned earlier, our stress testing also confirms this point. Then, how should we interpret the difference between the results of stress testing and market signals? The results of stress testing show that Japan's financial system has resilience to "acute" stresses comparable to the Lehman shock. However, even though financial institutions have sufficient capital at present, the stability of the financial system will not be guaranteed in the future if "chronic" stresses weigh persistently on many financial institutions' profits. If they fail to secure returns that meet their cost of capital for a More specifically, the Bank provided troubled financial institutions with funds needed to repay deposits through the Tokuyu. After these financial institutions failed, the Bank received full repayment of the Tokuyu from funds provided by the Deposit Insurance Corporation (DIC) to these institutions in accordance with the Deposit Insurance Act amended in 1996. In principle, the Tokuyu is an uncollateralized loan, but under such scheme, the Bank was not exposed to credit risk in extending the Tokuyu to deposit-taking financial institutions. (Meanwhile, the Bank bore credit costs in providing the Tokuyu and capital to securities companies.) Using stock market data, the CoVaR measures the size of stress in the financial system, which comprises the following two factors: the stress faced by individual banks and the comovement between the stresses faced by individual banks. prolonged period due to common and chronic stresses, we cannot exclude a possibility of simultaneous (or a chain of) impairment of capital held by many of the financial institutions that hold common exposure. With a price-to-book (P/B) ratio of less than one, the stock market seems to be sending us a warning about the impact of "chronic and common" stresses (Chart 3).7 III. Background of Regional Financial Institutions' Low Profitability Now, let me touch on the characteristics of the structure of financial institutions' profits before identifying "chronic and common" stresses that exert downward pressure on regional financial institutions' profits. International Comparison of Financial Institutions' Profitability The recent decline in financial institutions' profits is a phenomenon that can be observed not only in Japan but commonly in advanced economies, where the low interest rate environment has prevailed. However, even in this situation, the low profitability of Japanese financial institutions is striking from an international perspective (Chart 5). Regional financial institutions in particular have lower gross operating profits per employee than U.S. and European financial institutions of a similar size. Such low profitability is due not only to Japanese financial institutions' low net interest income that is susceptible to interest rate developments but also to low net non-interest income that is not susceptible to these developments.8 Since the 2000s, Japanese financial institutions have been making efforts to expand their fee and commission-based business with the aim of diversifying their profit sources, but the share of net non-interest income in gross operating profits (the net non-interest income Based on a stock yield model, the equation "P/B ratio = ROE (return on equity) / COE (cost of equity)" can be obtained after simplification. A P/B ratio of less than one implies that stock market participants expect that banks will not be able to make returns higher than their cost of capital. Net interest income is interest income such as loan interest income and security interest income net of interest expenses such as deposit interest expenses. Net non-interest income is mainly composed of the fees and commissions for services provided by banks such as funds transfer services, deposit-taking and lending services, and securities sales net of the fees and commissions paid to other banks (net fees and commissions). ratio) nevertheless is generally small from an international perspective (Chart 6). By size, whereas the net non-interest income ratio of major financial groups is on par with that of their U.S. counterparts, regional financial institutions' net non-interest income ratio is only around 10 percent, which is much lower than that of U.S. and European financial institutions of the similar size. For U.S. and European financial institutions, net non-interest income represents an important profit source as they increase opportunities to obtain various fees and commissions by meticulously setting the content of services based on characteristics and preferences of their clients. For example, in Europe, financial institutions secure a profit source by charging a reasonable fee for the issuance and use of debit and credit cards and providing bespoke solutions for high net worth individuals. Moreover, due to the spread of Internet banking, they also have started to impose fees for services such as paper-based balance statements. In the United States, fund management services that meet firms' outsourcing needs have been established as paid-for services. On the other hand, in Japan, there are more than a few examples where financial institutions do not impose any fees on financial services that incur a reasonable amount of costs, such as services related to account maintenance and management. These differences in the stance regarding the setting of fees and commissions for financial services in Japan and abroad also show up clearly in the composition of household consumption expenditure. The item composition of the consumer price index (CPI) in various countries shows that the weight of financial services in Japan is much lower than in the United States and Europe (Chart 7). Furthermore, in contrast to the United States and Europe, where the prices of financial services have been rising at an annual rate of about 2 percent, in Japan, the prices of financial services have for a long time essentially remained unchanged. These facts mean that whereas for financial institutions in the United States and Europe, fee and commission income from households forms a stable source of profits, Japanese financial institutions lack such profit source. Intensified Competition among Banks I have pointed out that financial institutions in Japan have lower gross operating profits per employee than their U.S. and European peers, and the breakdown showed that not only their net interest income but also their net non-interest income, which is not susceptible to interest rate developments, is low (Chart 5). These observations suggest that Japanese financial institutions' low profitability is due not only to persistent low interest rates but also to other structural factors. Specifically, one likely factor is that competition among financial institutions has continued to intensify for a long time. Looking at an international comparison of the number of financial institutions' branches that actually provide financial services, the number of financial institutions' branches per capita in Japan appears relatively low; however, if the number of post office branches, which provide bank agency services, is included, the figure is about the same as that in some European countries, which are regarded as being overbanked (Chart 8).9 Additionally, the number of financial institutions' branches per habitable land area is conspicuously large in Japan. Of course, this is also due to the high population density of Japan. But if financial institutions' branches are densely crowded in a small area, depositors and firms will have a number of branches to choose from. Thus, the state of competition among them will intensify.10 In particular, in terms of attracting deposits, financial institutions in Japan were competing intensely with each other, as well as with the postal savings system, from before World War II until recent years. Because deposit and lending margins were sufficiently large when interest rates were regulated, opening branches and collecting as much deposits as possible was rational behavior which would directly lead to profit growth for private financial institutions. For this reason, and partly due to competition from the postal savings system, it was difficult for private financial institutions to adopt a strategy of charging deposit-related fees. Even after deposit and lending margins narrowed against the backdrop of interest rate liberalization and the low interest rate environment, the fierce competition among financial institutions continued. Banks were fully aware that if only they started charging fees, it was highly likely that deposits would flow out to other banks or the post office. Under these circumstances, a business model premised on not charging deposit-related fees seems to become entrenched at financial institutions. Thus, as financial institutions have little net non-interest income and greatly depend on net interest income for profits, a decline in population and the number of firms spurs lending competition among financial institutions, With regard to overbanking in Europe, see European Systemic Risk Board, "Is Europe Overbanked?" June 2014. For details, see Chapter VI in the October 2017 issue of the FSR. pushing down net interest income in a structural manner. To sum up, the true identity of "chronic and common" stress that exerts downward pressure on regional financial institutions' profits is a persistent decline in population and the number of firms observed in almost all regions of Japan under the fierce competition among financial institutions (Chart 1). Our estimation results show that structural factors such as population decline, in addition to a decline in market interest rates due to monetary easing, have largely contributed to the shrinkage of deposit and lending margins of regional financial institutions over the past decade (Chart 9).11 While the forecast over the next 10 years will change depending on the future path of market rates, chronic stresses such as population decline are expected to continue to exert downward pressure on deposit and lending margins. That is, even if market rates rise and funding costs increase, loan interest rates will not be raised sufficiently due to intensified competition caused by chronic stresses. Thus, there is a possibility that deposit and lending margins will not improve very much. IV. Competition among Banks and Macroprudential Policy Going forward, the problem of financial institutions' low profitability is expected to be exacerbated, given the structural changes to the business environment, such as the shrinking regional population and business base. Next, I will go over how this will affect the financial system. Impact on Financial System Stability The decline in population and the number of firms, which is a structural factor underlying the intensified competition among financial institutions, is not an idiosyncratic shock occurring in certain areas, but a common shock occurring across Japan (Chart 1). Moreover, this common shock is not a temporary one but is expected to remain in the future. If such chronic stresses continue to exert downward pressure on regional institutions' profits, it becomes highly likely that financial institutions will engage in excessive risk taking. For Not only the effects of monetary easing but also a decline in the natural rate of interest associated with changes in demographic profile has contributed to a decline in market interest rates. Given this point, chronic stresses such as population decline may more significantly affect the long-term downward trend of financial institutions' deposit and lending margins. example, they may take on market risk associated with securities investment without proper risk management, or they may take on excessive credit risks in lending -- that is, extend loans at an interest rate that is not high enough to cover credit costs. At present, regional financial institutions do not take on excessive market and credit risks relative to their capital.12 However, the point is on how chronic stresses will have an effect in the future, and a warning from the stock market seems to address this point. In particular, because Japanese regional financial institutions' provision of non-interest services accompanying lending transactions is limited compared to their U.S. and European counterparts and Japanese major banks, the degree of differentiation in lending transactions is low, and they tend to engage in interest rate competition (Chart 6). In fact, financial institutions' lending stances have been as active recently as during the bubble period, while their lending margins tend to be narrower than planned under intensified competition among financial institutions (Chart 10). In other words, as demand for loans has been sluggish under the chronic stress of a decline in population and the number of firms, financial institutions have increased common exposure; namely, a decline in net interest income resulting from lending competition among financial institutions. I mentioned earlier that the CoVaR, a systemic risk indicator of regional banks, has been rising recently due to an increase in the comovement between the stresses (Chart 4). This seems to reflect the effects of an increase in common exposure caused by intensified competition. 13 Many regional financial institutions are not necessarily individually systemic institutions. Nonetheless, there are more than 500 regional banks, shinkin banks, and credit cooperatives in total, and these institutions face the chronic and common shock of a decline in population and the number of firms, and they hold common exposure of a decline in net interest income resulting from intensified competition. Therefore, regional financial institutions taken as a whole are systemic as a herd, and chronic stresses that they share in common could greatly affect the stability of the financial system through intensification of competition. For details, see Chapter IV in the October 2017 issue of the FSR. The FSR released in October 2017 empirically shows that intensified competition among regional financial institutions raises systemic risk. For details, see Box 3 in the October 2017 issue of the FSR. Impact on Financial System Efficiency Chronic stresses may affect not only the stability but also the efficiency of the financial system. The intensified competition among financial institutions amid the decrease in the number of firms has started to have an effect on the business relationships between financial institutions and firms. The average number of financial institutions that each firm transacts with across branches has been on an uptrend (Chart 11). As the number of firms within business areas is decreasing, financial institutions' efforts to look for new transaction opportunities and boost their corporate business seem to have led to an increase in the number of financial institutions that each firm transacts with. For firms, this means that they have been able to obtain more favorable loan conditions by increasing the number of financial institutions that each of them transacts with. However, if it becomes common for firms to choose the financial institution offering the lowest loan interest rate among a number of financial institutions when taking out a loan, regardless of whether the financial institutions have any transaction history or capacity to support businesses, business relationships between firms and their main bank will weaken. This may lower the efficiency of financial intermediation. Under relationship banking, financial institutions accumulate soft information that is difficult to quantify, such as a manager's talent and a project's future business value, by monitoring client firms through long-term business relationship. Based on this soft information, they can provide financial services including lending business. The following two advantages have been pointed out with regard to such relationship banking. First, by accurately assessing the future value of firms, financial institutions can encourage firms to engage in profitable investment projects while keeping firms away from inefficient ones. Second, if firms face funding difficulties due to external shocks, financial institutions that are well aware of the firms' future value can provide liquidity assistance. That is, for firms, they purchase liquidity insurance by paying a reasonable amount of loan interest rates. These two advantages contribute to the efficient allocation of funds across the entire economy. However, as lending margins narrow significantly due to intensified competition among financial institutions, they eventually will lose their incentives to engage in information production activities that are costly, such as the assessment of a manager's talent and a project's future business value. If financial institutions do not have sufficient information about their client firms, extended funds may be used for inefficient investment activities. Financial institutions may also become cautious about extending loans at their own risk to firms that face stresses. If financial institutions lose their information production capacity, they may try to obtain guarantee by credit guarantee corporations to loans to small and medium-sized firms, and may increase their incentive to shift their credit risks to the public sector.14 On the other hand, firms may prefer to transact with financial institutions that offer lower loan interest rates in normal times while they may depend more on emergency measures by the government or public finance in times of stress. This would generate a moral hazard. In the end, in the case of public finance with solid support, excessive lending competition among banks could undermine firms' incentives to raise their productivity. This could result in inefficient resource allocation across the entire economy, or hamper the economic natural selection mechanism. At present, firm-bank relationships have not weakened to this extent. However, if the competition among banks continues to intensify due to chronic stresses, how this will affect the efficiency of the financial system going forward warrants attention. V. Macroprudential Approach to Chronic Stresses I have explained that the chronic and common stress of a decline in population and the number of firms has exerted downward pressure on financial institutions' profits, adversely affecting both the stability and efficiency of the financial system by creating a highly competitive environment. This is a serious problem from a macroprudential perspective. How should we tackle this problem? This problem can be understood in the context of "market failure." Asymmetric information between a firm as a borrower and a bank as a lender can be resolved by long-term relationship and banks' information production capacity. However, if banks' loan interest rates decline to a level that cannot compensate for their information production costs, firm-bank relationships will weaken. In other words, the poor functioning of the loan market will leave the market failure arising from asymmetric information unresolved. On the other hand, if a bank ultimately can transfer a firm's credit risk to the public sector, the bank may be able to continue extending loans. In this case, however, taxpayer money will be used to bear the firm's credit cost in the end. Therefore, lending by banks that do not engage in information production activities entails negative externalities. This situation also causes a market failure. Unfortunately, it is difficult to solve this problem by utilizing the traditional macroprudential policy tools. If further bullish expectations of firms and households and banks' risk-taking operated in tandem and a higher degree of overheating was observed in the financial cycle, capital regulation such as the countercyclical capital buffer (CCyB) and credit regulation such as the loan to value (LTV) limit would be effective.15 However, as I have already mentioned, we do not face such a situation at this moment (Chart 2). In addition, in the case where financial institutions' low profitability is caused by chronic and common stresses, capital regulation that requires banks to accumulate capital is not an appropriate prescription. As accumulation of capital under such measures is expected to further reduce the profitability (ROE), it seems difficult for financial institutions with low profitability to increase their capital in the financial market.16 Microprudential Approach that Incorporates a Macroprudential Perspective In order to contain systemic risk among regional financial institutions, enhancing off-site monitoring and on-site examinations is the first important step. Off-site monitoring and on-site examinations are primarily regarded as a microprudential measure. By carrying them out from a macroprudential perspective in an industry-wide and collective manner, however, they are capable of producing effects as a form of macroprudential policy.17 The CCyB indicates a variable capital surcharge, one of the Basel III capital adequacy requirements. Capital reserves are required for materialization of potential losses in the banking sector, when risks in the financial system are expected to increase due to excessive credit extension. On the other hand, the restriction on the LTV ratio is concerned with the ratio of loans to the collateral market value in extending real estate loans. When risks in the real estate industry are expected to increase, lowering the LTV ratio would contain further credit expansion. When the tighter capital adequacy ratio is applied, banks have the following two options: increasing their capital (an action affecting the numerator) and/or (2) reducing their risky assets (an action affecting the denominator). If it is difficult to increase their capital, financial institutions will refrain from extending loans. Thus, there is a possibility that competition among them will become less intense. Depending on how much the capital adequacy ratio will be added, however, this measure can be a "powerful drug" that forces financial institutions with relatively weak capital bases to leave, and this does not seems a realistic option -- at least, this is not suitable for the first line of defense. In this regard, the Federal Reserve seems to have a similar awareness of the issues. Members of the Financial Stability Subcommittee of the Conference of Presidents (COP) of the Federal Reserve Banks conducted a macroprudential tabletop exercise in June 2015. The results of the exercise indicated that supervisory guidance and stress testing are more effective than capital regulation (such as leverage ratios and CCyB), liquidity regulation (such as liquidity coverage ratio and net stable funding ratio), and credit regulation (such as caps on LTV ratio). For details, see Tobias Adrian, et al., "Macroprudential Policy: Case Study from a Tabletop Exercise," Federal Reserve Bank of New York Staff Reports, No. 742 (2015). For example, a medium- to long-term simulation of financial institutions' profits is a valuable tool for communication with financial institutions. Based on line sheet review, the Bank specifically ascertains the actual situation of regional economies and changes in behaviors of financial institutions and then estimates the future prospects of profits while taking account of how much chronic stresses the future decline in population and the number of firms will exert in each business area.18 Stress testing is certainly important, but as many regional financial institutions currently have sufficient capital, most of their capital adequacy ratios are above the regulatory requirements even under the acute stress. What is significant to avoid systemic risk arising from chronic stress is not regional financial institutions' "current" solvency, but rather their "future" solvency. Therefore, in the case where a medium- to long-term forecast of profits based on the current business model shows a difficulty in maintaining highly sustainable profits and an adverse effect on future solvency and loss-absorbing capacity, even if financial institutions currently have enough capital, it seems relevant to ask them to enhance their business performances toward improving their profitability. To earn profits in a sustainable manner under a highly competitive environment, financial institutions need to differentiate the financial intermediation services they offer and make efforts to utilize their core competence. When formulating their business plans, it is important for them to (1) accurately analyze and identify the needs for financial services of the customers within their business areas and (2) develop and offer services that meticulously address customers' needs. Moreover, (3) another option to provide such services could be through the review of the efficiency of their branch configuration and allocation of employees, as well as the thorough management of profitability including fair price setting. Toward an Appropriately Competitive Environment Many regional financial institutions seem to have already recognized the importance of Specifically, during the line sheet review, the Bank ascertains and confirms business environments for borrowers such as developments in regional economies and industries, as well as credit exposure managements by conducting face-to-face meetings with branch managers based on the documents ("line sheets") that contain information about the selected individual borrowers, including changes in financial situations, changes in borrowing and repayment, their future prospects, financial institutions' self-assessment results, and policies for lending. enhancing business performances, but under the highly competitive environment, some have pointed out the difficulty in making efforts to steadily improve business performances. If competition among financial institutions leads to a decline in each other's profits, financial institutions are thought to be caught in the "prisoner's dilemma." Many of them mention that, if they mutually avoided the "excessive" interest rate competition, then they could maintain their profits. On the other hand, if only one institution left the competition, the customers would go to other institutions, resulting in the institution being an only loser. In such a situation, it becomes more difficult to leave the interest rate competition. Regarding the relationship between competition among banks and their business stability, "moderate" competition will lead to their business stability. However, if competition becomes fierce beyond a certain threshold, bank business will become rather unstable (Chart 12).19 In Japan, many regional financial institutions seem to have already been caught in the prisoner's dilemma. How should we address the prisoner's dilemma caused by fierce competition among banks? One effective option is consolidation and reorganization among financial institutions. As the number of firms and population continue to decline, the highly competitive environment will not relax unless there are changes in supply capacity, such as a decline in the number of financial institutions, their branches, and their employees. From a macroprudential perspective, Japanese financial institutions have overcapacity relative to financial service demand, which is determined by population and the number of firms. Consolidation and reorganization that could lead to the improvement of such a situation seem effective in enhancing the stability and efficiency of the financial system.20 There are two views with regard to the relationship between the competitive environment that financial institutions face and their business stability. The first is the "competition-stability view," which holds that competition among banks increases their business stability. The second is the "competition-fragility view," which holds that competition among banks lowers their business stability. The former argues that, as banks compete with each other and loan interest rates fall, borrowing firms' probability of default declines, raising banks' business stability. Conversely, the latter argues that, as competition intensifies and banks' profit margins continue to tighten, their capacity to absorb losses due to external shocks, such as an increase in credit costs, decreases and/or they take more risks, so that banks' business becomes unstable. For details, see Box 6 in the April 2017 issue of the FSR. In the non-financial private sector, competition policy mainly focuses on efficiency (competitive pricing). Meanwhile, in the banking sector, competition policy focuses on not only efficiency but also stability (prevention of systemic risk). For details, see International Monetary Fund, "Key Aspects of Macroprudential Policy -- Background Paper" (2013). Nevertheless, I think that it is most important for individual financial institutions to make the time horizon of maximizing their profits longer.21 Financial institutions' pursuit of profit in a myopic manner would lead to excessive interest rate competition. This would not only exert downward pressure on profits of individual financial institutions but also undermine the stability and efficiency of the financial system, adversely affecting both regional and nationwide economies in Japan. Consolidation and reorganization are indeed one of the options to improve future profits, but this is not all. Even if individual financial institutions did not choose consolidation and reorganization but instead focused on maintaining medium- to long-term profits in the future, they would find it more desirable to enhance information production capacity about client firms and construct a business model that differentiates the financial intermediation services they offer, rather than continue to engage in excessive interest rate competition. Such behavior of financial institutions will contribute to the improvement of both the stability and efficiency of the financial system and positively affect the economy over the long run.22 It is important to secure profits for each fiscal year. However, what is needed as a response to chronic stresses is tireless efforts to improve future profits, such as differentiation of financial services. Individual financial institutions should work for a business model that makes the time horizon of maximizing their profits longer. The Bank attaches great importance to the medium- to long-term forecast of profits in its off-site monitoring and on-site examinations, because a competitive environment and the time horizon to maximize financial institutions' profits are closely related. By carrying out off-site monitoring and on-site examinations in an industry-wide and collective manner, the Bank would like to encourage financial institutions to appropriately recognize their competitive environment and establish their business plans and models over a longer time horizon to maximize their profits. We consider this to be a new type of macroprudential policy. In game theory, if each player's discount factor is large enough -- that is, he/she focuses not only on this term's profits but also on future profits -- repeated games resolve the prisoner's dilemma. Long-term forecast in Chart 9 assumes that estimation parameters will remain unchanged from the ones estimated based on the past data. However, the parameters would change if the competition environment changed due to the progress in differentiation of financial services provided by financial institutions and consolidation and reorganization among them. In this case, even if the outlook for explanatory variables was unchanged, the impact of chronic stresses such as a decline in population on deposit and lending margins would diminish. How to Deal with the Social Norm for Services in Japan In order to avoid systemic risk arising from financial institutions' low profitability, there is one more issue that needs to be resolved, in addition to establishing an appropriately competitive environment. That is, to obtain the understanding of clients about fair compensation for the financial intermediation services. Presumably, many Japanese do not recognize that Japanese financial institutions continue to provide settlement services without obtaining an appropriate amount of compensation. Banks provide their depositors with financial intermediation services including settlement services, and in return they receive implicit fees in the form of deposit spreads (market interest rates - deposit interest rates). It is interpreted in standard economics that, instead of investing in government bonds and other assets in the financial markets, households and firms purchase settlement services from the banks by making a deposit with lower interest rates and paying opportunity cost of deposit spreads to the banks. Setting the fair price of settlement services by combining these deposit spreads with explicit fees such as account maintenance and funds transfer fees is the banks' standard business model. In Japan, however, deposit spreads fell to almost zero in the mid-1990s due to a decline in market interest rates after the bubble burst and the liberalization of deposit interest rates (Chart 13). This happened about 20 years before the introduction of the Bank's QQE and the negative interest rate policy. In other words, Japanese financial institutions that do not impose any account maintenance fees have provided settlement services for almost free over the last 20 years. They had an option to charge account maintenance fees when deposit spreads reached zero, but it was impossible in reality. There were two reasons. As I mentioned earlier, one was competition among financial institutions including the postal savings system. The other was the social norm for services in Japan.23 I think that the Japanese social norm for services has developed in a unique way compared to other countries. For example, when we look up the word "service" in a Japanese The another possible reason was that financial institutions were short of capital as a result of the disposal of nonperforming loans after the bubble burst, and they received public funds. In this situation, it was not socially acceptable to receive more fees from the Japanese people. dictionary, we find explanations such as "dedication," "discount," and "a free gift." For Japanese people, an expression like "family service," where the word "service" in Japanese is used as a synonym of family "duties" in English, sounds very familiar. "Overtime service" -- meaning volunteer overtime work -- and "we offer you some services!" -meaning that we offer customers services at a discount -- also sound familiar in Japan. As is evident from these examples, the Japanese word "service" implies the concept of "free of charge." On the contrary, no such meaning can be found in an English dictionary. As represented by the Japanese word omotenashi, which can be roughly summed up as "the spirit of selfless hospitality," offering services without requiring any pecuniary compensation in return is considered a Japanese virtue. The low productivity of the Japanese service sector including the financial sector by international standards does not seem to be unrelated to the social norm for services that is peculiar to Japan. The weight of financial services in household consumption expenditure is extremely low in Japan from an international perspective (Chart 7). On the flip side of the coin, Japanese financial institutions' net non-interest income ratio is also low (Chart 6). I think that these cannot be explained solely by competition among financial institutions. Currently, there are about 1.1 billion personal accounts at financial institutions across Japan. The number of bank accounts per capita amounts to about 10, and this is quite a large number on the basis of an international comparison (Chart 14). The reason the number of bank accounts is high seems to be largely because account maintenance fee is free in Japan. Banks incur massive costs to maintain such a large number of bank accounts. They even have to manage accounts that have no transactions for 10 years from the last transaction was made. As the system maintenance burden for these accounts incurs fixed costs, banks that are capital-intensive industry eventually fall into a vicious cycle where competition intensifies to achieve economies of scale. Maintaining bank accounts that do not contribute to economic transactions with heavy cost is socially inefficient. Moreover, it is likely to become more difficult for banks to continue providing settlement services without asking for fair compensation to maintain bank accounts.24 Probably, the social norm in Japan is something along the lines of "there is no way that fees are charged on hard-earned money deposited in a bank," but I think the time has come for the Japanese people to discuss fair compensation for financial intermediation services. Many of you may wonder why the assessment of fair compensation for services is related to macroprudential policy. However, the people's understanding regarding fair compensation for financial intermediation services is essential in order to ensure the stability of the financial system in the future. This is because (1) there is a risk that the vicious compounding of banks' low profitability and excessive competition among banks will destabilize the financial system, (2) banks' low profitability is partly due to their low net non-interest income, and (3) this is related to the social norm for services. Raising such an issue is unconventional from a macroprudential perspective, but I believe that this is an inevitable challenge to address. It should be noted, however, that we need to make various efforts to promote a discussion at the national level about fair compensation for financial intermediation services. First, the financial sector as a whole, including the Bank of Japan, needs to fully explain and gain the people's understanding of the fact that costs to provide settlement services are not balanced with profits. Second, needless to say, individual financial institutions need to conduct reforms to improve their profits. If there was room for cutting costs and making profits, the public would not fully recognize the need for fair compensation. In this regard, regional financial institutions need to reduce overcapacity by appropriately allocating business resources through Business Process Reengineering. Moreover, if financial institutions provide excessive services that do not necessarily match clients' needs, they may need to review the content of their services.25 And third, financial institutions need to gain better understanding from the people by providing new value-added in financial intermediation services based on the new technological environment, including FinTech. If financial Even if the number of bank accounts per capita is appropriate, the provision of settlement services entails costs. Settlement in demand deposits incurs costs to develop and maintain a stable and efficient system. Teller windows at branches involve indirect costs associated with identification and payment/receipt of cash. Moreover, issuance of a bankbook also exerts upward pressure on costs. In addition, if the profitability of similar services is different depending on supply channels, it will be necessary to build a fee structure that encourages clients' transactions to shift from a unprofitable channel to a profitable one; for example, to shift from bankbook- or paper-based transactions to Internet banking. institutions could further improve the efficiency and safety of financial services and receive compensation that meets clients' satisfaction, their productivity and profitability would increase. Conversely, if they did not engage in such efforts and only charged more compensation, there would be disintermediation amid an increased presence of FinTech firms. Thus, this point warrants careful vigilance. VI. Concluding Remarks Today, I have explained the prudential policy approach to financial vulnerabilities arising from chronic stresses. As advanced economies have never before been confronted with the chronic stress of a persistent decline in population and the number of firms, how to overcome this stress is a considerable challenge. However, I believe that the wisdom and foresight of those in the financial institutions' top management who have overcome various challenges surely will find a breakthrough. At the same time, we at the Bank of Japan, which is responsible for the stability of the financial system, have to explore a new frontier of prudential policy by ourselves. Nonetheless, no matter how hard we try to explore a new frontier, there is a limit to achieving financial stability by utilizing prudential policy alone. Chronic stress in the financial system can be regarded as a decline in Japan's growth potential or the natural rate of interest.26 Banks have been unable to receive fair compensation for the provision of settlement services due to the narrowing of deposit spreads. The underlying reason behind this seems to be a decline in the natural rate of interest that has caused a significant decline in nominal interest rates (Chart 13). Among the banks' two main businesses of settlement services and lending services, banks have been able to gain profits only from the latter business and have engaged in more intense interest rate competition. As market interest The natural rate of interest is an interest rate that balances savings and investment. It refers to the real interest rate that can be achieved when the real economy grows at its potential growth rate. Looking back at the saving-investment balance, excess saving in the household sector has narrowed, reflecting the aging population, while saving has been exceeding investment in the corporate sector since around the end of the 1990s. This seems to be because a persistent decline in the number of firms has led to a reduction in investment in the corporate sector as a whole, and a decline in population has restrained investment through a decline in the expected growth rate. The natural rate of interest declined toward the mid-1990s and has not recovered from a low level since then. This is due to a change in the saving-investment balance that has led to chronic stress and affected the financial system. rates have remained at low levels since the mid-1990s, the shrinkage of lending margins as a trend has been significantly affected by a decline in the natural rate on interest under such intensified completion. Based on such thinking, it is important to minimize the size of chronic stresses in order to maintain financial stability. Of course, it is essential to mitigate the impact of chronic stresses on the financial system by utilizing prudential policy. However, if chronic stresses remained severe, prudential policy would not easily take effect. The measures to minimize the size of chronic stresses, or the government's growth strategy to raise the potential growth rate and the natural rate of interest, play a vital role in fostering financial stability. Lastly, let me briefly touch on the effects of monetary policy on the stability of the financial system. The continued monetary easing, in addition to the chronic stress of a decline in population and the number of firms, is one of the factors that have intensified competition among financial institutions and exerted downward pressure on their profits. At the same time, monetary easing so far has encouraged the banks' more active lending and contributed to the improvement of firms' business performances. 27 This has manifested as an improvement in economic conditions, contributing to financial institutions' profits; for example, as seen in a decline in credit costs and an increase in returns on securities investment. The financial system constitutes a transmission channel of monetary policy, and its stability forms the basis for the sustainable economic growth. It is necessary that the Bank continue to conduct monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions.28 Looking back, both monetary policy and prudential policy have made great progress in the past 20 years.29 When the Bank was responding to Japan's financial crisis in the 1990s, I felt despondent even about the next day, but we roused ourselves with the slogan "never cause a financial contagion from Japan." Japan's safety net has gone through a long For details, see Box 2 in the April 2017 issue of the FSR. For details regarding how to incorporate a macroprudential perspective into the conduct of monetary policy, see Hiroshi Nakaso, "Challenges toward Financial Stability and the Policy Frontier: Unconventional Monetary Policy, Macroprudence, and Financial Institutions' Low Profitability," speech at the IVA-JSPS Seminar in Stockholm (March 21, 2016). For details regarding how the Bank's monetary policy has evolved, see Hiroshi Nakaso, "Evolving Monetary Policy: The Bank of Japan's Experience," speech at the Central Banking Seminar hosted by the Federal Reserve Bank of New York (October 18, 2017). challenging period and improved dramatically since the day when the word "macroprudence" did not exist and we lacked the experience of and tools for crisis management. As I have talked about today, knowledge regarding macroprudential policy has been accumulated and the remaining issues to be tackled have become clearer. We really have come a long way. It might be a little late, but I would like to express my deepest appreciation to all colleagues and friends who have devoted all of their knowledge and efforts toward achieving the stability of the financial system during the difficult times. Today marks 20 years since Dark November. On this day, I would like to conclude my speech by reiterating the Bank's unwavering determination as a central bank to guard the stability of Japan's financial system. Thank you very much for your attention. New Frontier of Macroprudential Policy: Addressing Financial Institutions' Low Profitability and Intensified Competition November 29, 2017 Speech at the Kin'yu Konwa Kai (Financial Discussion Meeting) Hosted by the Jiji Press Hiroshi Nakaso Deputy Governor of the Bank of Japan Decline in population and the number of firms Chart 1 Number of firms and population ten thou. mil. Changes in the number of firms from 2004 to 2014 (by municipality) Changes in population from 2015 to 2025 (by municipality, forecast) Number of firms (lhs) Population (rhs) CY 80 85 90 95 00 05 10 15 20 25 Note: 1. The number of firms is that of privately owned establishments, which cover single-unit establishments and head offices (headquarters and main offices). The "Establishment and enterprise census" is used in and before 2006, and the "Economic census for business frame and business activity" in and after 2009. 2. The dashed line in the left-hand chart represents forecasts. 3. The rates of change in population for municipalities in Fukushima Prefecture are substituted by the average rate of change in population for the prefecture. Source: Ministry of Internal Affairs and Communications; Ministry of Land, Infrastructure, Transport and Tourism; National Institute of Population and Social Security Research. Financial cycle Chart 2 % 2.5 2.0 Financial cycle (lhs) 1.5 Business cycle (output gap, rhs) 1.0 0.5 0.0 -0.5 -2 -1.0 -4 -1.5 -6 -2.0 -2.5 CY 85 -8 Note: Financial cycle is an indicator that aggregates 14 Financial Activity Indexes (FAIXs) shown in the Financial System Report, using timevarying weights that take the cross-correlation between these indexes into account. The indicator approaching +1 is a sign of "financial overheating" and approaching -1 is a sign of "financial contraction." Latest data as at the April-June quarter of 2017. Source: BOJ. EDF and P/B ratio of regional banks Chart 3 Short-term EDF 3.0 2.5 % Medium- to long-term EDF 25th-75th percentile range Median % P/B ratio 3.0 25th-75th percentile range Median times 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 CY00 02 04 06 08 10 12 14 16 CY00 02 04 06 08 10 12 14 16 FY 95 25th-75th percentile range Median Note: 1. The expected default frequency (EDF) and price-to-book (P/B) ratio cover 56 and 35 regional banks, respectively. 2. The short-term EDF is 1-year EDF, and the medium- to long-term EDF is 5-year forward EDF. Latest data as at end-September 2017. 3. Latest data as at end-fiscal 2016 for P/B ratio. Source: Bloomberg; Moody's; BOJ. Systemic risk indicators of regional banks： CoVaR Chart 4 CoVaR Individual risk (VaR) % pts 25th-75th percentile range Median % pts Comovement (β) 1.0 25th-75th percentile range Median 25th-75th percentile range Median 0.8 0.6 0.4 0.2 0.0 FY 96 98 00 02 04 06 08 10 12 14 16 FY96 98 00 02 04 06 08 10 12 14 16 FY96 98 00 02 04 06 08 10 12 14 16 Note: 1. Using stock market data, Conditional Value at Risk (CoVaR) measures the size of stress in the financial system, which comprises the following two factors: the stress faced by individual banks (VaR) and the comovement between the stresses faced by individual banks (β). The following relation holds among the indicators: CoVaR = β × VaR. 2. Covers 56 regional banks. Latest data as at fiscal 2016. Source: Bloomberg. International comparison of FIs' profits Chart 5 Net interest income and net non-interest income per employee mil. yen mil. yen Japan U.S. Europe Group 1 mil. yen mil. yen Japan U.S. Europe Group 2 Smaller-scale institutions Net interest income (weighted average) Net non-interest income (weighted average) Japan U.S. Europe Group 3 Japan U.S. Europe Group 4 Larger-scale institutions Net interest income (median) Net non-interest income (median) Note: 1. Covers 370 Japanese financial institutions (consisting of major banks, regional banks, and shinkin banks), 686 U.S. financial institutions, and 491 European financial institutions from the euro area, the United Kingdom, and Switzerland. Data are basically on a consolidated basis. Financial institutions in each region are classified into 4 groups based on quartiles of gross operating profits of Japanese financial institutions. For details, see the October 2017 issue of the Financial System Report. 2. The figures are the averages for the period from fiscal 2014 to fiscal 2016. The figures for U.S. and European financial institutions were converted into yen using purchasing power parity exchange rates (obtained from the OECD) for the period. Source: OECD; published accounts of each bank; S&P Global Market Intelligence; BOJ. International comparison of net non-interest income ratios Chart 6 net non-interest income / gross operating profits, % 75th-90th percentile range 25th-75th percentile range 10th-25th percentile range Weighted average Median Japan U.S. Europe Japan Group 1 U.S. Europe Japan Group 2 U.S. Europe Japan U.S. Europe Group 3 Group 4 Smaller-scale institutions Larger-scale institutions Note: The figures are the averages for the period from fiscal 2014 to fiscal 2016. Source: OECD; S&P Global Market Intelligence; BOJ. Share of financial services in household expenditure Chart 7 Price indices for financial services in the CPI Weights of financial services in the CPI 1.4 % 1.31 1.20 1.2 0.88 0.78 0.8 CY2005=100 0.99 1.0 0.66 Japan U.S. Canada EEA31 Switzerland 0.6 0.42 0.4 0.23 0.27 0.2 Italy U.K. Canada EEA31 Netherlands France Switzerland Germany U.S. Japan 0.0 0.01 CY 00 Note: 1. Weights in the CPI are on a 2015 basis. The latest data in the right-hand chart are as at July 2017. 2. EEA31 refers to the European Economic Area member countries, which cover 28 EU member states, Iceland, Liechtenstein, and Norway. Source: Haver Analytics; Ministry of Internal Affairs and Communications. International comparison of the number of FIs' branches Chart 8 Number of financial institutions' branches per capita 5,000 number of branches 4,000 48 47 44 42 3,000 2,000 25 24 18 17 U.S. Sweden U.K. Greece Netherlands Portugal Spain Austria France Switzerland Italy Germany U.K. Netherlands Sweden Japan Greece U.S. Belgium Germany Switzerland Japan + post offices Austria Germany + post offices Italy Portugal Spain France 1,000 Belgium Japan Germany + post offices number of branches Japan + post offices Number of financial institutions' branches per habitable area Note: The number of branches is per 100,000 population in the left-hand chart and per 10,000 km2 habitable area in the right-hand chart. Basically, data as at end-2015 (data for Japan as at end-fiscal 2015). Source: CUNA; ECB; Eurostat; FAOSTAT; FDIC; FSA; Ministry of Internal Affairs and Communications; published accounts of each entity; SNB; U.S. Census Bureau; BOJ. Regional FIs' deposit and lending margins Chart 9 Forecast over the next 10 years Results over the past 10 years 0.2 cumulative changes from FY2006, % pts cumulative changes from FY2016, % pts 0.0 -0.2 -0.4 -0.6 -0.8 FY 06 Credit risk factor Market interest rate factor Structural factors (incl. population growth) Deposit and lending margins 0.2 0.1 0.0 -0.1 -0.2 Structural factors (incl. population growth) -0.3 Deposit and lending margins (recovery scenario) -0.4 Deposit and lending margins (stagnation scenario) -0.5 FY 16 17 18 19 20 21 22 23 24 25 26 Methodology for decomposing and forecasting deposit and lending margins A panel estimation is conducted from fiscal 2001 to 2016 for regional financial institutions (FIs, covering 105 regional banks and 255 shinkin banks), regressing deposit and lending margins on the following explanatory variables: Market interest rate: Due to the zero lower bound on deposit interest rates, a decline in the market interest rate leads to the narrowing of deposit and lending margins. Moreover, when government bond yields decline, FIs further compete on loan interest rates to increase their loans. We use 5‐year JGB yields, taking into account the average maturity of bondholdings by regional FIs. 3‐year backward moving average is taken for the market interest rate to match the fact that both the deposit interest rate and the loan interest rate are calculated based on the amount outstanding. Population growth in business areas of each FI: When the population declines, sales of and loan demand from small enterprises (especially non‐ manufacturing ones) are expected to decline, which exerts downward pressure on the loan interest rate. Population aging in business areas of each FI: In areas where the population is aging, deposits tend to increase while the demand for housing loans decreases. This leads to the intensification of competition among FIs, lowering the loan interest rate. Number of branches in business areas of each FI: The higher the number of branches in the business area, the lower the deposit and lending margins. Nonperforming loan ratio of each FI: FIs with high nonperforming loan ratios tend to offer higher loan interest rates, reflecting their higher credit costs. Two different scenarios of the future market interest rate Market interest rate (5‐year JGB yields) is regressed on the nominal GDP growth rate, and using the estimated results, we assume that the market interest rate is 1.6% when the nominal growth rate is 2%, and 0.8% when the nominal growth rate is 1%. Recovery scenario: The economy follows a sustainable growth path with a nominal growth rate of 2% from fiscal 2019, and the market interest rate gradually rises to 1.6%. Stagnation scenario: The nominal growth rate remains lackluster at around 1%, and the market interest rate rises only to 0.8%. Note: 1. Contributions of population growth effect, population aging effect, and number of branches effect are put together as "structural factors." 2. As for population growth and population aging, forecasts by the National Institute of Population and Social Security Research are used. It is assumed that the nonperforming loan ratio and number of branches in business areas are constant throughout the forecast period. Lending attitudes of FIs Chart 10 DI for lending margins: plans and results (Loans to small firms) DI of lending attitudes of financial institutions % pts Results over the past 3 months Original series Accommodative % pts Plans for the next 3 months Trend Narrowing margins -10 Widening margins -5 -20 Severe -30 CY 80 -10 CY 06 07 08 09 10 11 12 13 14 15 16 17 Note: 1. Covers all firm sizes and all industries. Latest data as at the Note: 1. Latest data as at July 2017. 4-quarter backward moving averages. 2. Based on the proportion of responding financial institutions July-September quarter of 2017. selecting each given choice, the DI is calculated as follows: 2. The trend is calculated from the historical average. Shaded DI = "narrowing considerably" + 0.5 × "narrowing somewhat" areas indicate the root mean square of the deviation from － 0.5 × "widening somewhat" － "widening considerably." the trend. Source: BOJ, "Senior loan officer opinion survey on bank lending practices Source: BOJ, "Tankan." at large Japanese banks." Number of FIs that each firm transacts with Chart 11 Average number of financial institutions that each firm transacts with Distribution of the number of financial institutions that each firm transacts with frequency, % 3.0 number of financial institutions FY2005 FY2015 2.9 2.8 2.7 2.6 2.5 number of financial institutions FY 96 Note: The left-hand chart covers approximately 700,000 firms for which data for the entire observation period are available from fiscal 2005, and the right-hand chart covers approximately 450,000 firms for which data for the entire observation period are available from fiscal 1996. The latest data in the right-hand chart are as at fiscal 2015. Source: Teikoku Databank. Competition among FIs and their business stability Chart 12 Distribution of competition index among regional financial institutions Relationship between competition index and business stability (Z-score) 50 density, % Z-score More intense competition Less intense competition More intense competition Less intense competition FY1990 FY2000 FY2015 0.0 0.4 0.8 1.2 1.6 2.0 2.4 competition index (P-MC), % pts 0.0 0.4 0.8 1.2 1.6 2.0 2.4 competition index (P-MC), % pts Note: 1. Z-score is an indicator that measures a financial institution's business stability and is defined as the ratio of a financial institution's lossabsorbing capacity to the volatility of profits. 2. The left-hand chart shows the cumulative effects of markup (P-MC) changes on the Z-score, by using the following estimated equation: Z-score = (30.18 × (P-MC) － 11.52 × (P-MC)2) / (1 － 0.84). 3. The shaded area indicates the range over which a decline in the competition index (P-MC), suggesting more intense competition among financial institutions, leads to a decline in the Z-score and hence lowers a financial institution's business stability. 4. Density in the right-hand chart is estimated by using the Gaussian kernel function. 5. For details, see the April 2017 issue of the Financial System Report. Natural rate of interest and deposit and lending margins Chart 13 Natural rate of interest and nominal interest rates Decomposition of deposit and lending margins % % Lending spread (A-B) Loan interest rate (A) Deposit spread (B-C) Market interest rate (B) Deposit and lending margins (A-C) Deposit interest rate (C) Natural rate of interest -2 -2 CY 85 CY 85 Note: 1. Loan interest rate is an average contract interest rate on short-term loans outstanding. Aggregate of domestically licensed banks. Market interest rate is the 1-year government bond yield. Latest data as at the July-September quarter of 2017. 2. Natural rate of interest is estimated following Laubach and Williams (2003). Latest data as at the April-June quarter of 2017. Source: Bloomberg; Ministry of Finance; BOJ. Chart 14 Number of bank accounts per capita: international comparison Number of settlement accounts (excluding savings accounts) based on internationally comparable statistics 3.5 3.0 number of accounts (*) 2.5 2.0 1.5 1.0 0.5 Italy Germany France U.K. Netherlands Belgium Japan 0.0 (*) Covers only demand deposit accounts held at all financial institutions (excluding the Japan Post Bank). Including time and savings deposit accounts and accounts held at the Japan Post Bank, etc., the number of personal accounts per capita amounts to about 10. Note: Data as at end-2011 for U.K., as at end-fiscal 2015 for Japan, and as at end-2015 for other countries. Source: BIS, "Red Book."
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bank of japan
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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, Fukushima, 30 November 2017.
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November 30, 2017 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Fukushima Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Fukushima Branch. The Bank has implemented quantitative and qualitative monetary easing -- or QQE for short -- since April 2013 and introduced various additional measures such as the negative interest rate policy and yield curve control, all with the aim of achieving the inflation target of 2 percent. As a result of these measures, Japan's economy has been improving. Of course, I know that many people argue that, although the economy is said to be improving, they are not feeling the effects of this improvement because the real economic growth rate has been just a little over 1 percent on average recently. However, this is the first time in 16 years that the economy has registered positive growth for seven consecutive quarters, from the January-March quarter of 2016 through the July-September quarter of 2017. Today, I would like to explain monetary policy measures conducted by the Bank and what they have achieved, and then discuss what to make of arguments circulating with respect to the purported dangers of bold monetary policy. I. Monetary Easing Measures and Economic Activity The Bank has implemented QQE since 2013, with the aim of achieving the inflation target of 2 percent. As a result, the money stock and lending have been growing at a faster pace. Moreover, due to the decline in nominal interest rates and the rise in inflation expectations, real interest rates -- nominal interest rates minus expected inflation rates -- have declined considerably. What sorts of results has this had for economic activity? Chart 1 shows developments in major economic indicators. The chart shows that production, exports, consumption, and aggregate supply of capital goods (a proxy variable for business fixed investment) all started to recover when QQE was introduced, or even slightly before then. However, consumption and production became sluggish following the consumption tax hike in 2014. This sluggishness appears to have become pronounced on the whole particularly since the end of 2014, when exports decreased with the slowdown in world trade. Nevertheless, economic indicators as a whole in Japan have been recovering in line with the recovery in world trade that began around mid-2016. Chart 1 Achievements of Bold Monetary Easing Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 s.a., CY 2010 = 100 Introduction of QQE with Yield Curve Control Sep. 2016 └ └ Industrial production World trade volume Real exports └ └ └ └ Real consumption activity index Aggregate supply of capital goods Sources: Ministry of Economy, Trade and Industry, "Indices of Industrial Production," "Indices of Industrial Domestic Shipments and Imports"; CPB Netherlands Bureau for Economic Policy Analysis, "CPB World Trade Monitor"; Bank of Japan, "Real Exports and Real Imports," "Consumption Activity Index." These economic indicators experienced ups and downs after the introduction of QQE, but one indicator that has continued improving almost constantly is employment. Chart 2 shows developments in the number of employees and the unemployment rate. It has been said that, although the number of employees increased, this was limited to non-regular employees. However, the share of non-regular employees among all employees has leveled off. Looking at the shares of non-regular and part-time employees among all employees in the Labour Force Survey released by the Ministry of Internal Affairs and Communications and the Monthly Labour Survey released by the Ministry of Health, Labour and Welfare, we see that both peaked out after the turn of 2017. Chart 2 Improvement in Labor Market Conditions Introduction of QQE million % (April 2013) Number of regular employees Before QQE After QQE Number of full-time employees Regular employees Number of part-time employees +0.6% (annualized) +2.0% Unemployment rate (right scale) Youth unemployment rate (age 15-24 years, right scale) Full-time employees -0.1% (annualized) +1.6% Part-time employees +2.3% (annualized) +3.1% CY Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Productivity Also Has Risen Since the introduction of QQE, there has been heated debate over the importance of growth strategy; this is because, even though employment has increased, productivity has not risen, and economic growth will not continue without a rise in productivity.1 In fact, however, productivity has risen, as indicated in Chart 3. Productivity shown in the chart is estimated by the Organisation for Economic Co-operation and Development (OECD) and represents real purchasing power parity GDP per hour worked. QQE began in 2013, yet Japan marked Igarashi Takanobu, "Seichō senryaku de keizai wa seichō suru ka," Mitsubishi UFJ Research and Consulting Co., Ltd., July 2013, http://www.murc.jp/thinktank/rc/column/igarashi/column /igarashi130716. the highest rate of increase in productivity among major countries from 2012 to 2016, with an annual rate of 1.2 percent. Japan's average for the 10 years prior to this was 0.8 percent; therefore, Japan's productivity rose even after the introduction of QQE. Moreover, the capital-labor ratio per worker has declined.2 This means that productivity would have risen even further if there had been sufficient investment. Chart 3 Change in Productivity in Major Countries U.S. dollars CY France (2012-16: 1.0%) Germany (2012-16: 0.8%) Italy (2012-16: 0.2%) Japan (2012-15: 1.2%) United Kingdom (2012-16: 0.3%) United States (2012-16: 0.4%) Note: Productivity is represented by real GDP per hour worked, converted by PPP exchange rates in 2010. The figures in parentheses show the annualized growth rates from 2012 to 2015 or 2016. Source: OECD, "Level of GDP per capita and productivity." When growth accounting methodology was developed several decades ago, the growth rate of an economy's output was decomposed into capital inputs, labor inputs, and technological progress (total factor productivity). The results obtained through this methodology showed that the contribution of technological progress to the economic growth rate was 80 to 90 percent. I am reminded of the heated argument prevailing at the time that, despite such results, unless new capital investment is made, new technology cannot be adopted, and thus See Cabinet Office, Annual Report on the Japanese Economy and Public Finance 2017, July 2017, figure 16. technological progress should include capital inputs -- namely, capital-embodied technological progress. This argument has not received much attention in recent years; however, it is true that, if demand does not grow, then new investments cannot be made, and if new investments cannot be made, then equipment featuring advanced technologies cannot be used. It is wrong to view supply and demand as being separate, and to consider that Japan's economic problems are rooted in the supply side of the economy.3 I would like to note that monetary easing measures and growth strategy are not in opposition to one another, but actually complement each other. What is more, deregulation as part of growth strategy includes measures aimed at improving the efficiency of existing industries, thereby reducing employment. On such occasions, monetary policy measures will make it easier to carry out deregulation by improving the economy and producing labor shortages. The Economy Has Improved, despite Claims That People Are Not Actually Experiencing Such Improvement It is often claimed that, although the government says that the economy has improved, the public is not actually experiencing this improvement in their daily lives. However, how should we measure the public's perceptions regarding their daily lives in the first place? Public opinion polls offer clues in this regard. Chart 4 shows answers to the following question in a public opinion poll: "How would you describe the lifestyle of your household compared to this time last year?" For growth accounting and capital-embodied technological progress, see, for example, David N. Weil, Keizai seichō [Economic Growth], 2nd ed., trans. Hayami Hiroshi and Hayami Hitoshi (Tokyo: Pearson Kirihara K.K., 2010), 183-86, 216-17. It seems that recent macroeconomics textbooks do not emphasize the concept of capital-embodied technological progress. Chart 4 Sense of Improvement in Lifestyle Compared to Last Year % % points -10 -20 -30 -40 -50 -60 -70 CY Jan. 1974 Nov. 1974 May 1975 Nov. 1975 May 1976 Nov. 1976 I do not know Deteriorated Remained the same Improved "Improved" minus "deteriorated" (right scale) Note: This graph was made by the Bank's staff based on the Public Opinion Survey on the Life of the People conducted by the Cabinet Office. The surveys conducted in 1954 and 1955 asked the respondents "Have your household circumstances of late improved, deteriorated, or remained the same compared with around this time last year?," while those conducted between 1959 and 1991 asked "How would you describe your household circumstances compared to this time last year? Have they become better off, worse off, or remained the same?" The surveys conducted from 1992 ask "How would you describe the lifestyle of your household compared to this time last year? Has it improved, deteriorated, or remained the same?" English translation of these questions was prepared by the Bank's staff. The question is phrased somewhat differently depending on the survey year. The question was asked only of the odd-numbered respondents in the 1971 survey, and of the even-numbered respondents in the January 1974 survey. The figures for the 1972 and 1973 surveys were calculated by the Bank as the average of the results for the odd-numbered and even-numbered respondents. From the 1999 survey, the share of "I do not know" has been calculated by subtracting the shares of all the response options from the total. Sources: Cabinet Office, Public Opinion Survey on the Life of the People; Bank of Japan. The chart shows that only a very small number of respondents answered that their household circumstances or lifestyles have become better off or improved compared with one year ago. While the proportion of such respondents is currently slightly over 5 percent, even during the period of high economic growth between the mid-1950s and the early 1970s, when real GDP grew by around 10 percent every year, the only period when more than 10 percent of people replied that their circumstances or lifestyles had become better off or improved was from 1959 to 1963.4 The results indicate that people do not feel the effects In the time-series data of the Public Opinion Survey on the Life of the People conducted by the Cabinet Office, the share of respondents answering that their household's lifestyle "improved" exceeded 30 percent during the high economic growth period. This figure, however, requires attention because of the following. The surveys conducted between 1965 and 1991 and in 1994 first asked "What aspects of your household's lifestyle have improved compared with around this time of improvement in the economy. Nevertheless, looking at an indicator derived by deducting the share of respondents who answered that their household circumstances or lifestyles have "deteriorated" from the share of those who answered that these have "improved," it appears to be moving very closely in line with economic developments. After rising in 2013, the indicator fell due to the consumption tax hike, and since then it has been rising again together with the steady improvement in the economy. II. Arguments against QQE As I mentioned so far, Japan's economy has been improving due to QQE, which began in April 2013. However, there are always those who are against QQE. I consider that these opposing views can be divided into three arguments. The first states that there is no relationship between QQE and the current improvement in the economy, and that the economy would have improved even without QQE. The second argument states that QQE has produced positive effects for some people, but that it also has produced negative effects for a number of others. The third argument is that, although QQE may be bringing about positive results at the moment, it most certainly will give rise to extremely serious problems in the future. last year? Choose from among the following" (the choices were as follows: food; clothing; durable consumer goods such as electrical appliances, furniture, and automobiles; housing; leisure; other; and nothing has improved). The survey then asked "When viewed on the whole, do you think that your household's lifestyle has improved, deteriorated, or remained the same compared to last year?" (the question is phrased somewhat differently depending on the survey year). Since the question was posed in such a specific manner, many people were likely to have answered that their household's lifestyle has "improved," recalling, for example, electrical appliances that they newly purchased or family trips taken that year as opposed to not taking any the previous year. For this reason, for surveys conducted between 1965 and 1991 and in 1994, Chart 4 shows responses to "Have your household circumstances of late improved, deteriorated, or remained the same compared with around this time last year?" -- a question that did not ask about specific aspects that improved in their lifestyle. The only difference in the questions is the phrase "lifestyle" and "household circumstances." Moreover, a possible reason why only a small number of people responded with "improved" over the years is that this question does not offer "somewhat improved" in the response options. The First Argument: There Is No Relationship between QQE and Economic Improvement Let me start with the first argument. As I have explained so far, improvements have been seen in a number of indicators since the introduction of QQE; thus, I can hardly believe the claim that Japan's economy would have improved even without QQE. Nevertheless, it is difficult to technically prove my view that QQE has brought about improvements in Japan's economy, because it is impossible to compare the situation of the economy from 2013 up to the present between cases where QQE has been implemented and where QQE has not been implemented. What I can compare is merely the situation before the implementation of QQE -- that is, until 2012 -- and after the implementation -- from 2013. Because the economic situation differs between these periods, the effects of QQE cannot be technically proven by this comparison. Given this, it is necessary to terminate QQE now in order to make my argument more convincing. If QQE is terminated and the economy deteriorates, many people would believe that the economic upturn had been driven by QQE. Nevertheless, this experiment will not be persuasive enough because of the differing economic situations between the period through 2012 and from 2013. Should this experiment be carried out, interest rates will soar, the yen will jump, stock prices will crash, and the economy will plunge into recession. Such a dangerous test must not be carried out. In addition, it is possible without such a reckless experiment to make an assessment that compares Japan's economy through 2012 and from 2013 up to the present by adjusting the situation of the economy in each period to be as similar as possible. The results obtained from this assessment show that QQE has exerted its intended effects. For example, Professor Ryuzo Miyao at the University of Tokyo -- a former Policy Board member of the Bank -- presented an analysis based on a vector autoregression (VAR) model that the impact of an expansion of the monetary base raised production and the inflation rate.5 Miyao Ryuzo, "Hi dentōteki kin'yū seisaku no kōka wa aru no ka 2," chap. 3 in Hi dentōteki kin'yū seisaku [Unconventional Monetary Policies] (Tokyo: Yuhikaku Publishing Co., Ltd., 2016). Moreover, making comparisons of the economic situation in Japan with those in various other countries that adopted monetary easing during different phases will support my argument. For example, during the Great Depression, the U.S. economy recovered steadily when it abolished the gold standard and shifted to monetary easing in April 1933, but it fell back into recession when the level of monetary easing was reduced from 1936 to 1937.6 Chart 5 shows developments in real GNP, the money stock (M2), and prices in the United States during the Great Depression in the 1930s. It is evident that real GNP and prices dropped significantly in line with the decline in M2, and recovered steadily with the increase in M2. Then, in 1937, real GNP and prices declined again as M2 decreased, showing that it was a failure to exit from monetary easing too early. However, as monetary easing was resumed, real GNP started to recover from 1938 with the increase in M2. Chart 5 Real GNP, Prices, and Money Stock in the United States during the Great Depression billion U.S. dollars CY 1929 = 100 Real GNP (prices in 1929) M2 Index of wholesale prices (right scale) CY Source: Robert J. Gordon, The American Business Cycle, The University of Chicago Press, 1986. Adachi Seiji, "Ryōteki kanwa no deguchi wa nihon keizai ni totte kiken ka," chap. 8 in Abenomikusu wa shinkasuru: Kin'yu ganseki riron o tou, ed. Harada Yutaka, Kataoka Goushi, and Yoshimatsu Takashi (Tokyo: Chuokeizai-sha, 2017). As I mentioned earlier, it is actually difficult to totally refute the argument that Japan's economy would have become better even without QQE. However, by referring to a number of cases in the past, I believe that it is now understood that it was monetary easing that brought about the recovery in Japan's economy. The Second Argument: The Effects of QQE Have Not Become Widespread The second argument is that QQE has produced positive effects for some people but also has produced negative effects for a number of others. For example, labor shortage is certainly a favorable condition for job seekers, but it is a potential disadvantage from the standpoint of employers. Nevertheless, I feel that it is better to suffer from a lack of people who engage in selling, manufacturing, and transportation for a marketable product than from the problem of a product that is not selling. If a product that is not selling comes to pose a management crisis, it will become necessary to cut employment, which is a hard task for managers. After the 2008 financial crisis, I heard from numerous corporate managers that they were forced to cut their workforce and had never before had such a painful experience. I cannot imagine that there are any managers in Japan who would find it easy to cut their workforce. This is why I feel that it is much better to have too few people than too many. Some argue that only a limited number of people receive the benefits from the economic recovery and that benefits do not reach them. This argument goes that, although income has risen on the whole, many people do not experience much increase in income and income disparities have expanded. Let us take a look at how income distribution changed after the introduction of QQE. According to the Comprehensive Survey of Living Conditions 2016 released by the Ministry of Health, Labour and Welfare, the child poverty rate (the share of children aged 17 or under living in households with equivalent disposable income at or below 50 percent of the median) fell from 16.3 percent in 2012 to 13.9 percent in 2015.7 In this same survey, the overall poverty rate fell from 16.1 percent to 15.6 percent over this period. There is another argument that QQE has put the banking industry in a difficult situation, saying that low interest rates are squeezing bank profits. But one of the major reasons for such a situation is that banks are suffering from a lack of borrowers. In Japan, private nonfinancial corporations as a whole have been experiencing excess net savings, and their currency and deposits accumulated to as much as 254 trillion yen as of end-June 2017.8 Of course, it is natural that bank profits are squeezed if long-term interest rates decline, because banks generally raise short-term funds and invest them in long-term assets. However, if we simply compare long-term interest rates and bank profits, it does not seem appropriate to say that low interest rates always reduce bank profits. Chart 6 shows developments in banks' operating profits from core business and long-term interest rates (10-year Japanese government bond [JGB] yields). Operating profits from core business represent stable earnings of banks, such as profits earned from fund management in the form of lending and securities investment, for example. Interest rates have fallen in a mostly consistent manner since 1990, yet I do not believe that this is correlated with banks' operating profits from core business. For example, even though interest rates fell in the first half of the 1990s, operating profits recovered. In 1999, when the zero interest rate policy was introduced, operating profits rose along with interest rates. In 2001, the quantitative easing policy was introduced, yet operating profits rose thereafter. Both operating profits and interest rates fell following the termination of quantitative easing, but this is largely due to the 2008 financial crisis. After the introduction of QQE in 2013, due to the improvements in the economy, the financial situation of borrowing firms Equivalent disposable income is calculated by dividing household disposable income by the square root of the number of people in the household. It is believed to represent the standard of living per member of the family. The reason for using the square root instead of the number of people itself in the calculation is that there are costs of living shared among the members of the household, which tend to become lower per person as the number of people in the household grows larger. Equivalent disposable income is thought to make it possible to compare per capita disposable income between households with different numbers of people in the household. Bank of Japan, Flow of Funds Accounts (2nd Quarter 2017; Preliminary), September 2017. improved, credit costs decreased, and banks' net income increased.9 In other words, bank profits are affected by the situation of the economy as a whole, in addition to developments in interest rates. Although operating profits from core business fell in fiscal 2015 and 2016, I think that this is partly due to the sluggishness of the economy that followed the consumption tax hike. It is true that banks' net profits have been declining since fiscal 2016, but I would like to emphasize that they had been improving prior to that. Chart 6 Financial Institutions' Operating Profits from Core Business Introduction of the zero End of the zero Introduction interest rate policy interest rate policy of QE Feb. 1999 Aug. 2000 Mar. 2001 trillion yen End of QE Mar. 2006 Introduction of QQE Apr. 2013 % -1 FY Shinkin banks Regional banks Major banks JGB yields (right scale) Note: Non-consolidated base. Operating profits from core business are calculated by subtracting general and administrative expenses from the sum of net interest income and net non-interest income. Figures for "JGB yields" represent 10-year JGB yields. Source: Bank of Japan. Net income is calculated by deducting credit costs, such as loan-loss provisions, from the sum of operating profits from core business and the profits and losses on sales of securities. Other items such as extraordinary gains/losses are also added/deducted. Furthermore, if bank profits depend on a rise in nominal interest rates, QQE is a policy that will lead to an increase in interest rates in the end. This is because interest rates also rise when prices rise. If interest rates are raised even though prices are not rising, then the economy will deteriorate, prices will fall, and interest rates will have to be reduced further. I believe that such policy measures continued from the 1990s until the introduction of QQE.10 Looking ahead, I believe that prices will rise, and that we can expect to see interest rates rise along with them. The Third Argument: QQE Will Cause Serious Problems in the Future Lastly, let me turn to the argument that QQE may be bringing about positive effects at the moment, but most certainly will give rise to extremely serious problems in the future. The argument goes that, at some point, monetary easing will suddenly give rise to hyperinflation, a collapse of the yen, a surge in interest rates, a plunge in bond prices, and so forth. 11 However, such fears are not at all likely to happen. Given this, the argument seems to have converged on the discussion that the Bank will face significant problems of making large losses for a protracted period when it heads toward an exit from monetary easing -- that is, when it reduces the level of monetary easing. Regarding this argument, it is of course possible that the Bank may register losses. Those who support this argument claim that, when the public merely acknowledges the possibility that the Bank may register losses -- even if such a thing does not actually happen -- the yen will collapse and Japan's economy will experience hyperinflation. 12 However, if this argument is valid, why is the collapse of the yen or hyperinflation not happening now? I often ask this question, but have never received an answer. For the relationship among nominal interest rates, financial institutions' profits, and monetary policy, see Harada Yutaka, "Naze nihon no kin'ri wa hikui no ka," Keiki to saikuru, no. 62, Japan Association of Business Cycle Studies, November 2016. In Harada, Kataoka, and Yoshimatsu, Abenomikusu wa shinkasuru, this sort of theory is criticized by referring to it as the "big rock theory." In "The Role of Capital for Central Banks" (the outline of a speech given at the Fall Meeting of the Japan Society of Monetary Economics on October 25, 2003), Kazuo Ueda provided the general opinion that, when a central bank falls into capital deficiency, a loss of credibility in the central bank causes a depreciation of the currency, a high rate of inflation, a functional decline in payment systems, and other problems (note that Mr. Ueda is not necessarily stating this as his own opinion). I consider that the Bank may register losses on its statement of income at the exit from monetary easing, but believe that nothing negative will happen to the economy. I will explain the reason behind my view. Let us first look back in history. Since 1980, as far as I can confirm, there have been about 20 cases in which central banks recorded losses or fell into capital deficiency. 13 Although details are not available for all cases, countries that suffered from economic turmoil such as inflation were Jamaica, the Philippines, and Venezuela in the 1980s and 1990s. On the other hand, inflation rates did not rise in West Germany in the 1970s, the Czech Republic in the 1990s-2010s, Chile from the 1990s up to the present, or in Switzerland in the 2000s and 2010s. The reason why economic turmoil did not happen in these countries is clear. Most of the assets of central banks in these countries are foreign assets. If inflation occurs, the value of their countries' currencies depreciates, whereas the value of foreign assets denominated in their home currencies appreciates. In other words, there is a mechanism in which, if impairment of central banks' assets brings inflation, inflation itself recovers the value of these assets. Therefore, it is impossible that serious problems will occur because of central bank losses. Why, then, could sharp inflation not be restrained in Jamaica and other countries? In these countries, central banks increased money to assume government debt and issued high-interest-bearing bonds to absorb the increased money. As a result, these central banks made losses due to increased interest payment.14 It is a matter of course that, if central banks issue banknotes to assume government debt, they inevitably will suffer from inflation regardless of their financial situation. In the case of Japan, however, as I have explained on Reza Vaez-Zadeh, "Implications and Remedies of Central Bank Losses," in The Evolving Role of Central Banks, ed. Patrick Downes and Reza Vaez-Zadeh (Washington: International Monetary Fund, 1991). Peter Stella, "Central Bank Financial Strength, Policy Constraints and Inflation," IMF Working Paper, WP/08/49, International Monetary Fund, February 2008. Stella, "Central Bank Financial Strength." Mario B. Lamberte, "Central Banking in the Philippines: Then, Now and the Future," Discussion Paper Series No. 2002-10, Philippine Institute for Development Studies, September 2002. various occasions, the fiscal deficit has been decreasing after the introduction of QQE.15 The ratio of the general government deficit to GDP has declined significantly from 8 percent in 2012 -- the level before the introduction of QQE -- to 2 percent in 2016. Of the 6 percentage point decrease, 1.5 percentage points, or 8 trillion yen, is due to the consumption tax hike in 2014, and the remaining 4.5 percentage points is due to the economic recovery brought about by economic stimulus measures such as QQE.16 In addition, the Bank of Japan employs a price stability target of 2 percent. This means that, when the timing of achieving the 2 percent price stability target is in sight, the Bank will taper monetary easing or tighten monetary policy. This situation totally differs from that in Jamaica or other countries that experienced sharp inflation. Why Does the Exit Pose a Problem? As I explained earlier, in the 1980s and 1990s, the situations in Jamaica, the Philippines, and Venezuela were completely different from that in Japan, and as for countries such as Switzerland, central bank assets consist of foreign assets. Given this, I believe that there are doubts over what will happen in countries where the majority of assets consist of government bonds denominated in their own currencies, such as Japan. "Exit" here refers to the Bank's termination of monetary easing followed by an increase in interest rates and a reduction of the monetary base because achieving 2 percent inflation is in sight as a result of monetary easing. At the exit, the Bank will have to raise interest rates. By way of example, possible ways to do so are as follows: by abandoning the negative interest rate policy currently carried out by the Bank and raising the interest rate applied to excess reserves, or by selling JGBs held by the Bank. At this point in time, the Bank has not reached any decisions on an exit policy. It is easier to understand the topic by thinking in terms of hiking the interest rate applied to excess reserves, and so I would like to explain it in this way. Those who contend that the exit will See, for example, Harada Yutaka, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Gifu," Bank of Japan, June 2017. A reduction in fiscal deficit decreases the possibility that the Bank of Japan will have to assume such deficit. Ministry of Finance, Japanese Public Finance Fact Sheet 2017, April 2017, 24. be dangerous make the claim that, even if the Bank raises the interest rate on excess reserves, the interest rates on JGBs that it purchased in the past will remain low, and therefore the Bank will suffer enormous losses. It is certainly possible that the Bank could suffer losses because it will receive a low yield despite paying out a high yield. Such proponents explain that, if the Bank suffered losses, then confidence in the currency would be undermined, and this would lead to hyperinflation, the collapse of the yen, and a surge in interest rates. However, while yields on even JGBs at present are around 0 percent, they were 3 percent until about the middle of the 1990s. The reason is that, at that time, the real economic growth rate was high and prices were rising. If prices rise, interest rates will also rise eventually. This means that it will be possible to purchase higher yielding JGBs. Of course, until that time, the Bank will have to hold low yielding JGBs while paying high yields to banks in order to prevent an overheating of the economy. However, in the end, the central bank will always make a profit in the long run, since it buys high yielding JGBs using cash and current account deposits that carry almost no costs. Thus, the Bank will not make a loss in the long run that could pose a danger. In the first place, over the course of monetary easing in Japan, the economy improved and the fiscal deficit to GDP ratio also improved, backed by an increase in tax revenues; thus, focusing on the Bank's deficits that will temporarily occur at the time of the exit is an argument that fails to see the forest for the trees. Some are of the opinion that, because central banks in the United States and Europe are heading for the exit, Japan should follow suit. However, it makes perfect sense to me that Japan's exit should come later than theirs. To begin with, although inflation rates in the United States and Europe are below 2 percent, they are hovering at around 1.5 percent. This differs from the situation in Japan, where the rates do not reach even 1 percent. Furthermore, Japan introduced the quantitative easing policy -- which was large in terms of scale -- in 2013, whereas the United States and Europe started theirs in 2008. Because of the difference in the timing of starting such policy, it is no surprise that the timing of the exit differs as well. III. Path toward Achieving the 2 Percent Price Stability Target As I mentioned earlier, QQE has produced significant effects so far. There is no basis to the claims regarding the dangers or side effects of QQE. The only problem is that prices have not risen. In relation to this, it is often questioned why wages and prices have not risen despite labor shortages.17 My answer is simply that labor shortages have been insufficient. When wages increase, so do prices. This is because, although a rise in wages increases costs, these costs are easily passed on to prices due to increased demand caused by a rise in income. Since my time here is limited, I would like to focus on prices. Chart 7 shows the Phillips curve representing the relationship between the inflation rate and the output gap in Japan. The regression lines shown here indicate this relationship for each of the following periods: from the January-March quarter of 1983 to the January-March quarter of 2013, from the January-March quarter of 1983 to the October-December quarter of 1995, from the January-March quarter of 1996 to the January-March quarter of 2013, and from the April-June quarter of 2013 to the July-September quarter of 2017. All of these regression lines show that, unless the output gap exceeds about 2.5 percent, the inflation rate does not reach 2 percent. Looking at the regression line for the period from the January-March quarter of 1983 to the October-December quarter of 1995, it is evident that the output gap necessary to achieve 2 percent inflation is about 2.5 percent, and the observed inflation rate at the time was 1.5 percent. It can be concluded that, if inflation rates continue to rise at about 1.5 percent and the output gap rises to about 2.5 percent, then 2 percent inflation will be achieved. Since the current output gap is in the range of 1.0-1.5 percent, in order to achieve 2 percent inflation, the positive output gap needs to further widen to about 2.5 percent, and at the same time, the inflation rate must continue to rise at about 1.5 percent. Genda Yuji, ed., Hitode busoku na noni naze chingin ga agaranai no ka (Tokyo: Keio University Press, 2017). Chart 7 Phillips Curve CPI (less fresh food and energy), y/y % chg. 1983/1Q-2013/1Q 2013/2Q-2017/3Q B D -1 C D: 2013/2Q-2017/3Q y = 0.2636x + 0.5654 R² = 0.1722 -2 A -3 -8 % A: 1983/1Q-2013/1Q y = 0.3592x + 0.6789 R² = 0.4862 B: 1983/1Q-1995/4Q y = 0.2042x + 1.5045 R² = 0.334 C: 1996/1Q-2013/1Q y = 0.2141x - 0.0057 R² = 0.4253 -7 -6 -5 -4 -3 -2 -1 Output gap (2-quarter lead, %) Introduction of consumption tax Apr. 1989 Consumption tax hike Apr. 1997 Consumption tax hike % Apr. 2014 CPI (less fresh food and energy, y/y chg.) Output gap (2-quarter lead, right scale) -2 -4 -1 -6 -8 -2 Note: The CPI figures are adjusted for changes in the consumption tax rate. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Formula A B C D CPI = 0.36 × output gap + 0.68 CPI = 0.20 × output gap + 1.50 CPI = 0.21 × output gap - 0.01 CPI = 0.26 × output gap + 0.57 Estimate of the output gap corresponding to 2% 3.7％ 2.4％ 9.4％ 5.8％ Avg. growth rate of the observed CPI (annualized) 0.5％ 1.5％ -0.3％ 0.5％ Why Is 2 Percent Inflation Necessary? I would like to explain why 2 percent inflation is necessary by referring to the Bank's official view and adding my personal views. My interpretation of the Bank's official view on this matter can be summarized as follows. First, aiming at achieving 0 percent inflation entails the risk of actually aiming for deflation, given the upward bias of the consumer price index (CPI). Second, the equilibrium interest rates -- which are achieved in the long run -- tend to be lower on a nominal basis when the aim is 0 percent inflation. That being the case, there will be virtually no room for lowering interest rates should the economy fall into recession. In order to avoid this, it is necessary to provide a so-called buffer for nominal interest rates by raising the inflation rate. What is more, inflation can be dealt with by raising interest rates, and thus inflation can be considered to be easier to deal with than deflation. Third is the global standard. Given that other major countries aim at achieving 2 percent inflation, if Japan were the only country with a lower target, this would result in an appreciation of the yen, which would create turmoil in firms' investment plans. If Japan maintains the same inflation rate as other countries, I feel that this will serve to stabilize foreign exchange over the long term. Of these theories, I would like to add explanations for why I support the second and third points. The buffer theory of interest rates in the second point is completely different from the one advocated by the Bank in the past. The previous theory aimed at raising interest rates preemptively even when the economic recovery was insufficient, because if interest rates were too low, it would be difficult to implement stimulus measures during recessions. Such monetary policy resulted in a complete failure.18 The transcript of the February 2007 Monetary Policy Meeting, at which an interest rate hike was decided, was released on July 31, 2017. In relation to this, in an interview by Jiji Press, Kazumasa Iwata -- who was deputy governor in 2007 -- said that it was a failure to raise interest rates. In the same interview, Atsushi Mizuno -- who was a Policy Board member in 2007-- said that he thought it was better to raise interest rates by a certain degree in order to secure a buffer for monetary easing when the economy deteriorated (reported by Jiji Press at 8:52 a.m. on July 31, 2017). Mizuno's view explains the Bank's past thinking on the buffer. The correct theory regarding the buffer should be raising interest rates after confirming that price increases have gained enough momentum. I would like to emphasize that the Bank's current thinking on the buffer theory is totally different from the previous incorrect one. As for the third point, I believe that the stability in foreign exchange rates led by the global standard theory holds true to a certain degree. The yen's exchange rate against the U.S. dollar since the introduction of QQE with the 2 percent inflation target has moved in the range of 100-120 yen, and appears to be roughly stable at around 110 yen. I think that this situation can be described as stable, taking into account that the yen rose from 120 yen to 80 yen against the dollar around the time of the 2008 financial crisis. Moreover, there is another reason for the Bank's committing to the 2 percent inflation target; namely, we cannot fully grasp the actual degree of the current economic recovery. Specifically, we do not actually know the exact structural unemployment rate, the bottom line that will lead to inflation if lowered any further. If the Bank had terminated monetary easing based on estimates that the structural unemployment rate was about 3.5 percent, the current unemployment rate of 2.8 percent would not have been achieved.19 I think that we probably will be able to achieve an even lower unemployment rate. The reason why the lower unemployment rate was achieved and a bubble has not occurred is because the inflation rate is set as the direct target for monetary policy. Moreover, given the rise in The following publications showed that the structural unemployment rate was in the range of about 3.0-3.5 percent using unemployment-vacancy analysis. Ministry of Health, Labour and Welfare, Analysis of the Labour Economy 2015, September 2015. Cabinet Office, Annual Report on the Japanese Economy and Public Finance 2015, August 2015. Bank of Japan, "The Bank's View" in the Outlook for Economic Activity and Prices, October 2014. The Bank, from the April 2015 report, deleted the description regarding the structural unemployment rate from the main text of "The Bank's View" and added the following in a footnote to "The Bank's View": "This rate [the structural unemployment rate] is calculated to be around 3.5 percent or lower recently under a specific methodology." Then, from the April 2016 report, this description was deleted from that footnote and instead moved to a footnote to "The Background." From the July 2016 report, the actual level of the structural unemployment rate referred to in that footnote was replaced by the following expression: "the structural unemployment rate defined here differs from the concept of Non-Accelerating Inflation Rate of Unemployment (NAIRU), and does not show a direct relationship with prices or wages." On the other hand, developments in the structural unemployment rate have been provided in a chart in the report that shows that the rate is currently approximately 3 percent. wages, nonmanufacturing firms are making efforts toward streamlining business processes and making labor-saving investment. Concluding Remarks Now, let me wrap up my remarks. The Bank's QQE has resulted in expanding the money stock, lending, and so forth. Both nominal and real interest rates have fallen. This in turn has resulted in increases in production, exports, consumption, and business fixed investment. There are always those who argue against QQE, but as I have already explained, there is no basis to any of these arguments. The only problem is that prices have not risen. In relation to this, it is often questioned why wages and prices have not risen despite labor shortages. My answer is simply that labor shortages have been insufficient. If the current monetary policy is maintained, labor shortages will intensify further as the economy improves, and there will be a phase in which both wages and prices increase. If their momentum is strong enough, the Bank will start reducing the level of monetary easing. Some argue that there will be dangers associated with an exit from monetary easing as the Bank heads toward reducing the level of monetary easing, but as I have explained, there are no such dangers. Thank you for your attention.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris EUROPLACE Financial Forum, Tokyo, 4 December 2017.
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December 4, 2017 Bank of Japan Innovation and the Future of Finance Remarks at the Paris EUROPLACE Financial Forum in Tokyo Haruhiko Kuroda Governor of the Bank of Japan I. Paris International Expositions in the 19th Century -- Exploring the Future through New Technologies -It is a great honor to have the opportunity to give a speech at the Paris Europlace Financial Forum today. Nowadays, rapid innovation in information technology is significantly changing financial services, and even the economy and society as a whole. It seems that people are thrilled to watch, with hope and a little anxiety, how such innovation will change the world landscape and affect the role of human beings. Similarly, there was a time in the past when people had strong interest in how new technologies would change the future. Particularly in the late 19th century, with the development of heavy industry, the popularization of electricity, and mass production of new materials such as iron and glass, people wondered how such technological progress would change the economy and society. During that period, Paris hosted international expos as many as five times. These expos presented prospects of the 20th century that new technologies could open up, and brought these technologies closer to ordinary people. Indeed, many major structures using new materials and construction methods were built at the time of these expos, namely, la tour Eiffel, la Gare d'Orsay, le Pont Alexandre III, and le Grand Palais. They continue to be symbolic landmarks of Paris today. Moreover, very interestingly, Bordeaux wine classification was also introduced at the 1855 Paris Expo, and it seems that creating such a "database" has helped French wines become the world's leading brand. The Paris Metro was also opened during the 1900 Paris Expo. The subway has played a major role in urban transportation systems since the early 20th century. I am particularly attracted by the Art Nouveau decorations at the entrances of the Paris Metro. Art Nouveau widely adopted new materials such as iron and glass, combined with the delicate artistic sense of human beings, and created a path for the future of fine art and architecture. II. Innovation in Information Technology and FinTech Undoubtedly, the Paris Expos in the late 19th century presented "visions" and "prospects" of how science and technology could lead to economic and social development and improve people's daily life in a wide range of fields, such as urban architecture, transportation, and fine art. They thereby contributed to the broad application of science and technology in the 20th century. I believe we can also make use of such historical analogies for maximizing the value of on-going rapid innovation in information technologies. If many people could share the visions and prospects as to how these new technologies could contribute to making the world better and what they could bring to our daily life, the benefits would be substantial. Namely, we can intimately feel the benefits of new information technologies and cope with the associated anxiety through sharing these visions and prospects. If so, it would become easier to facilitate collaboration among various entities in applying these new technologies to improve financial services and develop the economy. In this regard, application of new information technology toward financial innovation, called "FinTech," will present the following visions or prospects that will open up the frontiers of financial services. I would like to encourage wide-ranging stakeholders to make efforts to realize them. First, FinTech will facilitate the delivery of financial services customized to suit individual users around the world. More specifically, in emerging and developing economies, where financial infrastructure such as bank branches and ATMs are underdeveloped, the Internet and smartphones are spreading very rapidly. In these countries, FinTech enables the provision of financial services by using the Internet and smartphones as new access tools. Therefore, emerging and developing economies are eager to promote FinTech in order to accelerate "financial inclusion." Moreover, big data and artificial intelligence (AI) makes it possible to customize financial services in accordance with the needs of individual users. Second, FinTech will contribute to increasing the efficiency of financial operations and services and raising productivity through the application of information technology. FinTech also has the potential to create new networks between financial services and wide-ranging industries, such as the Internet of things (IoT), e-commerce, and the sharing economy. By fostering the development of new sources of growth, FinTech could contribute to boosting growth potential through enhancing productivity, which is now a common policy challenge to developed countries. Furthermore, FinTech will improve our daily life and address various social challenges from the financial aspect. For example, as population is aging in Japan and many other developed countries, it is becoming increasingly important to make financial transactions easier and safer for the elderly and to protect them from fraud. In this regard, biometrics and AI could be effective tools. In addition, new technologies such as AI and big data analysis may enable rapid credit assessment and low-cost remittance services. They could facilitate easier access to lending and remittance services for financially vulnerable people. Moreover, robot advisers utilizing AI may provide easy-to-access asset management services with lower costs, and thereby promote "the shift from savings to investment," which is a long-standing policy challenge in Japan. In this way, FinTech could contribute to raising growth potential and addressing social challenges, not only in emerging and developing economies but also in developed countries. On this basis, major cities such as Paris and Tokyo consider FinTech as one of the major driving forces in the efforts of promoting financial services and industries. In November 2016, the Metropolitan Government of Tokyo established the "Advisory Panel for Global Financial City Tokyo," in which a senior official of the Bank of Japan participated. In the discussion there, FinTech, as well as fostering asset management services, were considered core drivers for promoting financial activities in Tokyo. III. Initiatives at the Bank of Japan and the Central Bank's Perspective The Bank of Japan is actively promoting FinTech from the standpoint of a central bank. In April 2016, the Bank established the FinTech Center within its Payment and Settlement Systems Department. The Bank has also built up a Bank-wide "FinTech Network" to share information and expertise related to FinTech. Also, the Bank has held four FinTech Forums so far. In these Forums, we have focused on topics of high interest, such as information security, open innovation, distributed ledger technology (DLT), and big data. In November 2016, the University of Tokyo and the Bank of Japan held a joint conference focusing on the future of money. Moreover, in April this year, the Bank organized a conference on AI. Furthermore, in order to gain deep understanding on new information technologies and their impact, the Bank has been conducting various research activities, including the joint research with the European Central Bank on DLT. In parallel with these activities, senior officials of the Bank, including myself, have been delivering speeches focusing more on IT innovation and FinTech as well as their impact on finance and the economy, in order to convey the Bank's views on these issues. When we try to examine the impact of FinTech on finance and the economy from a central bank's perspective, I think the following four points are important. First, entities which provide financial services are becoming widespread. One of the major characteristics of FinTech is that various new players such as IT companies and start-ups, which are different from traditional financial institutions, are entering financial service businesses. It would be informative to examine how these new players could influence the structure of financial service provision, financial markets, and risk-sharing among various entities. From a central bank viewpoint, we need to closely monitor the impact of these new entrants so that new technologies will enhance the efficiency of payments, settlements, and financial services, while ensuring their safety and stability. Second, new styles of systemic importance may emerge under the development of FinTech. Since the global financial crisis, efforts have been made to classify big banks as systemically important financial institutions, or SIFIs, based on factors such as the size of the balance sheet. Based on these efforts, various financial regulatory measures have been taken so that their systemic importance would not threaten financial stability. Recently, however, entities that provide global IT platforms to many entities and accumulate huge volumes of big data have become increasingly powerful and influential in wide-ranging businesses including financial services. In addition, high-speed, high-frequency transactions in financial markets are expanding, and if many market participants come to use similar algorithms in conducting such transactions, this might involve the risk of amplifying one-way market developments. Based on these changes in environment, rather than the size of balance sheets of banks, factors such as global IT platforms, the huge volumes of big data, and widely used algorithms might become more systemically important from the viewpoint of financial stability. Third, as the utilization of big data is becoming more important in the provision of financial services, data security, privacy, and the consensus of stakeholders on data utilization will become even more critical. Thus, financial service providers and stakeholders are required to pay due attention to data protection and privacy, in order to maintain public confidence in innovative financial services utilizing new technologies. Finally, as application of AI to financial operations is becoming widespread, ensuring governance in AI's decision-making and accountability to customers using AI-related services may also become critically important. If customers are concerned that AI's decision-making might turn into a "black box" and poses risks to them, such customers' anxieties would hinder the application of AI to create innovative financial services. In this regard, efforts to ensure the governance and accountability of AI are meaningful to "wipe out" people's concern about new technologies. IV. Closing Remarks In promoting FinTech, France and Japan seem to have common challenges as developed countries. In the case of emerging and developing countries, basic financial services are underdeveloped, and market growth can be expected to a certain extent, simply by introducing and promoting these basic services. On the other hand, both in France and Japan, basic financial services are already embedded in people's daily life. Thus, in order to make FinTech bloom in these countries, it is strongly needed to create innovative financial services with high added-value beyond already-available services. In addition, financial institutions are required to take forward-looking measures to reform their own structures in order to make effective use of FinTech. Without such efforts, the countries where traditional financial services already prevail might lag behind in the field of FinTech. In this regard, let me introduce another important aspect of the Paris Expos in the late 19th century. At that period, Japan was in the middle of a big transition phase, from the Edo period to the Meiji era. Nonetheless, Japan very actively participated in the Paris Expos. It seems to me that Japanese people, who were in the midst of a big historical turning point, were driven by their strong motivation to learn as much as possible from European countries, which were already the most industrially-advanced countries in the world. I feel that Japanese people really wanted to obtain prospects for the future and to gain clues for reform. At the same time, many ukiyo-e prints were brought to France from Japan. The interaction between Western and Oriental arts and the consequent "chemical reactions" led to the creation of new fine arts, namely, Japonisme and Impressionism, which remarkably incorporate both Western and Oriental cultural backgrounds. These histories vividly illustrate that interactive dialogue, which is sometimes carried out across borders, and chemical reactions brought by cross-cultural exchange play critical roles in innovative creation. Needless to say, both France and Japan have their own history and culture, and are now playing leading roles in science and technology. I firmly believe that it is extremely beneficial for these two countries to strengthen dialogue also in the areas of financial innovation and FinTech. The Bank of Japan would like to further deepen exchanges with the Banque de France on financial innovation and FinTech. Thank you for your attention.
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Speech by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 6 December 2017.
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December 6, 2017 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Hyogo Takako Masai Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices I would like to start my speech with a look at developments in economic activity and prices. At the Monetary Policy Meeting held on October 30 and 31, 2017, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices through fiscal 2019. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas Economies Let me first touch on developments in overseas economies. The Bank's assessment is that overseas economies have continued to grow at a moderate pace on the whole. In terms of the outlook, advanced economies are projected to continue growing steadily, and a recovery in emerging economies is likely to take hold on the back of the steady growth in advanced economies and the effects of policy measures taken by emerging economies. A similar view was presented in the World Economic Outlook (WEO) released in October 2017 by the International Monetary Fund (IMF). In recent years, the IMF has often revised downward the projections for global growth, but from early fiscal 2017, it has revised them upward. Looking at developments by major region, the U.S. economy has continued to recover, 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 also has continued to recover steadily and it will likely follow a moderate recovery trend. The Chinese economy will likely continue to broadly follow a stable growth path as the authorities conduct fiscal and monetary policy in a timely manner. Other emerging economies and commodity-exporting economies have picked up on the whole, particularly reflecting an increase in exports, the past bottoming out of commodity prices, and the effects of economic stimulus measures in those economies. The growth rates of these economies are likely to increase gradually, due mainly to the spread of the effects of steady growth in advanced economies. In my view, the downside risks to the global economy have been diminishing on the whole, partly because concerns over the financial sector in Europe have abated. In this situation, I am paying particular attention to firm international commodity prices; namely, crude oil prices. While uncertainties regarding the global economic outlook have been easing, it is likely that commodity-related fixed investment, which has been curtailed over the last few years, will start increasing. I expect there to be a strong possibility of the global economy continuing its steady growth through fiscal 2018. B. Japan's Economy and Price Developments 1. Current situation Now I would like to discuss developments in economic activity and prices in Japan. The Bank's assessment is that Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. In fiscal 2017 to date, the Bank has revised up its economic assessment twice. Industrial production has been on an increasing trend, reflecting the increases in demand both at home and abroad, and labor market conditions have continued to tighten steadily. As a result, the output gap -- which captures the utilization of labor and capital -- has improved steadily. On the domestic demand side, business fixed investment has been on a moderate increasing trend with corporate profits and business sentiment improving. According to the September 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment plans for fiscal 2017, especially those of large enterprises, showed firms' solid stance. This is evidenced by, for example, the fact that fixed investment on a basis close to GDP definition saw a year-on-year increase of 6.9 percent -- a level clearly exceeding the past average of 4.9 percent for the September Tankan surveys during the period of fiscal 2004-2016. Private consumption has increased its resilience against the background of steady improvement in the employment and income situation, and housing investment has been more or less flat. Exports have been on an increasing trend on the back of the growth in overseas economies that I mentioned earlier. One of the features of the ongoing expansionary phase is that the economy has been growing across a wide range of regions, firm sizes, and industries in comparison with past expansions. In the latest September 2017 Tankan, the diffusion index for business conditions in small firms reached its highest level in almost 26 years. In the Regional Economic Report, many regions have revised their economic assessments upward in 2017. Indeed, the Kinki region, which includes Hyogo Prefecture, has revised up its assessment in the two previous reports released in July and October. On the price front, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.5-1.0 percent. 2. Outlook I will now look at the outlook for Japan's economy during the projection period, which covers from fiscal 2017 through fiscal 2019. The economy is likely to continue its 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. Exports are expected to continue their moderate increasing trend along with the growth in overseas economies. Reflecting this outlook, Japan's economy is likely to maintain growth during this projection period at a pace above its potential, mainly through fiscal 2018. In fiscal 2019, it is expected to continue expanding, although the growth pace is projected to decelerate due to a cyclical slowdown in business fixed investment and the effects of the consumption tax hike scheduled in October 2019. Looking at the medians of the Policy Board members' forecasts in the October 2017 Outlook Report, the real GDP growth rate is projected to be 1.9 percent for fiscal 2017, 1.4 percent for fiscal 2018, and 0.7 percent for fiscal 2019. Let me explain the outlook in detail by major component. First, business fixed investment is likely to continue increasing moderately. This is because, in a situation where extremely stimulative financial conditions are maintained, fixed investment will be positively affected by (1) an improvement in corporate profits, (2) the materialization of the effects of projects conducted under the Fiscal Investment and Loan Program, and (3) moderate improvement in growth expectations. Specifically, an increase is likely to be seen in investment, particularly (1) that related to the 2020 Olympic Games and urban redevelopment projects, (2) that aiming at improving efficiency and saving labor in order to deal with the labor shortage, and (3) in research and development for growth areas. Private consumption is expected to follow a moderate increasing trend, due mainly to an increase in employee income as well as replacement demand for durable goods, and housing investment is expected to remain more or less flat. Exports are likely to be firm as a trend for the time being, underpinned by those of IT-related goods and capital goods, in which Japan has a comparative advantage. Thereafter, they are expected to continue their moderate increasing trend, due mainly to the improvement in overseas economies. Industrial production will likely continue to increase firmly for the time being, and thereafter is projected to continue on a moderate increasing trend. The year-on-year rate of change in the CPI (all items less fresh food) is likely to increase toward around 2 percent. This is because, although upward pressure of energy prices is likely to wane gradually, firms are likely to gradually shift their stance toward raising wages and prices with an improvement in the output gap, and inflation expectations are expected to accelerate moderately. In the short run, the rate of increase in prices of food products and goods related to daily necessities in particular is expected to accelerate gradually with a moderate increase in private consumption, and moves to pass on the increase in labor costs to prices of general services, including dining-out and housework-related services, are likely to prevail. Looking at the medians of the Policy Board members' forecasts in the October 2017 Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is projected to be 0.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and -- on a basis excluding the effects of the scheduled consumption tax hike -- 1.8 percent for fiscal 2019. I believe that there are the following upside and downside risks to the outlook. Risks to Japan's economic activity are developments in overseas economies, such as the U.S. economic policies and geopolitical risks, firms' and households' medium- to long-term growth expectations, as well as fiscal sustainability in the medium to long term. Risks to prices are developments in firms' and households' medium- to long-term inflation expectations, the fact that there are items for which prices are not particularly responsive to the output gap, as well as developments in foreign exchange rates and international commodity prices going forward. I hold the view that, while downside risks to Japan's economic activity are limited, those to prices are fairly significant. This is particularly so because of the considerable uncertainty as to how far firms will adopt a shared attitude toward raising prices. II. The Bank's Monetary Policy Next, I will talk about the Bank's monetary policy. With a view to achieving the price stability target of 2 percent, the Bank has been maintaining highly accommodative financial conditions by pursuing strong monetary easing. A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control The framework of QQE with Yield Curve Control the Bank has adopted consists of two major components. The first is an "inflation-overshooting commitment" in which the Bank commits itself to continuing to expand the monetary base until the year-on-year rate of increase in the observed CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. It aims at raising inflation expectations by demonstrating the Bank's unwavering determination. I will come back to this point again later. The second component is "yield curve control," in which the Bank controls short-term and long-term interest rates. In the current framework, it sets the short-term policy interest rate and the target level of the 10-year Japanese government bond (JGB) yields as its operating targets. At present, in the guideline for market operations, the Bank sets the short-term rate at minus 0.1 percent and the target level at around 0 percent, and conducts JGB purchases so as to achieve this target level. B. The Aim of Strong 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 JGBs and (2) raising inflation expectations through the Bank's strong commitment to the 2 percent price stability target. These factors lead to a reduction in real interest rates. Now, why does the Bank think that it is necessary to reduce interest rates to extremely low levels? The basic mechanism of monetary easing consists of driving real interest rates below the interest rate neutral to economic activity and prices; that is, the natural rate of interest. Japan's natural rate of interest has followed a downward trend, mainly reflecting the deceleration in the potential growth rate.1 The estimation results obtained by the Bank's staff suggest that the natural rate of interest has been at around 0 percent recently. Given that estimates of the rate differ depending on the methodologies employed, they should be regarded as being subject to a considerable margin of error; however, the results show that the rate has been at an extremely low level. Therefore, in order to realize accommodative financial conditions with such a low level of the natural rate of interest, it is necessary to bring interest rates down further. I consider that the current highly accommodative financial conditions -- created by the yield curve control in this way -- have strongly supported Japan's economic activity from the financial side. C. Toward Changing the Norm for Prices Japan's economy has suffered 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. One likely reason why it has been taking time for the deflationary mindset to be dispelled in Japan is that households and firms have been adaptive to the deflationary environment. Despite the strong monetary easing being pursued for almost five years, the 2 percent price stability target has not been achieved. This confirms that the deflationary mindset was more Such a downward trend in the natural rate of interest is not unique to Japan, but rather is a global phenomenon. This is one element behind the fact that, since the global financial crisis, interest rates in Japan, the United States, and Europe have declined to lower levels than ever before. persistent than initially had been assumed, although there were external factors such as the substantial decline in crude oil prices. Having said that, it is still necessary to pursue strong monetary easing; that is, to drive real interest rates sufficiently below the natural rate of interest. Meanwhile, almost five years have passed since the Bank introduced QQE, and I believe that the positive effects and side effects of QQE continue to warrant careful examination. Recently, price increases around the world have been relatively weak, and many have been pointing out that the factors behind this are the deepening of globalization and digitalization. As research on these factors is still in progress, the empirical evidence has not yet yielded conclusive results.2 I consider it important to fully take into account the effects of such changes in the economic structure on prices. However, even if the effects stemming from globalization and digitalization have been pushing down prices in advanced economies to some extent, I think price developments in Japan are quite different from those in the United States and Europe. This is because inflation expectations seem to be anchored at around 2 percent in the United States and Europe, with the price indexes showing that the underlying trend has been at around 1.5 percent, despite the past experience of the substantial decline in crude oil prices. On this point, in Japan, the year-on-year rate of change in the CPI (all items less fresh food) remains in the range of 0.5-1.0 percent -- as I mentioned earlier -- and that in the CPI (less fresh food and energy) is still in the range of 0.0-0.5 percent. In order to achieve the 2 percent price stability target in Japan, it is necessary that (1) the deflationary mindset be dispelled, and (2) the perception that prices of goods and services as well as wages are supposed to go up every year by around 2 percent becomes firmly entrenched in society as a whole -- or, in other words, the 2 percent inflation takes hold as a The well-known argument that a global approach should be taken into account in the basic determinants of inflation is one made by Claudio Borio, Head of the Monetary and Economic Department of the Bank for International Settlements (BIS). For the recent empirical analysis, see the following: Auer, Raphael, Claudio Borio, and Andrew Filardo. "The globalisation of inflation: the growing importance of global value chains." BIS Working Papers no. 602 (January 2017). https://www.bis.org/publ/work602.pdf. Meanwhile, there has been no confirmation of any noticeable, direct influence of global slack on domestic inflation, according to the analysis conducted by economists from the Federal Reserve Board. For details, see the following: Ihrig, Jane, Steven B. Kamin, Deborah Lindner, and Jaime Marquez. "Some Simple Tests of the Globalization and Inflation Hypothesis." International Finance vol. 13, issue 3 (December 2010): 343-375. Federal Reserve Board staff have updated the latter analysis using data through early 2017, and have confirmed that their argument remains valid. norm for prices. In this regard, it is essential that the Bank be committed in its conduct of monetary policy so as to achieve the price stability target, as I mentioned earlier. In the meantime, maintaining effective communication between the Bank and the government is crucial. Furthermore, nationwide changes are needed in the overall behavior and awareness toward prices. Of firms that have raised prices of their products and services recently, many have done so for the first time in more than two decades, and at present, firms themselves have limited experience in terms of raising prices. Moreover, consumers are not yet accustomed to an environment where both wages and prices increase at a certain pace. Thus, a change in the norm does indeed mean changes in various aspects of society. Financial literacy -- the next topic I will touch upon -- may seem unrelated to economic activity and prices or monetary policy at first, but I believe it does in fact have a connection with changing the norm I just described. III. Initiatives to Improve Financial Literacy A. Global Awareness of the Importance of Financial Education The importance of financial education has been reaffirmed worldwide in the wake of the global financial crisis. In 2012, the Organisation for Economic Co-operation and Development (OECD) developed the High-Level Principles on National Strategies for Financial Education, which was then endorsed by the G-20 at their summit in Los Cabos later that year. According to the OECD, financial education is not merely the dissemination of financial knowledge, but "the process by which financial consumers/investors improve their understanding of financial products, concepts and risks and, through information, instruction and/or objective advice, develop the skills and confidence to become more aware of financial risks and opportunities, to make informed choices, to know where to go for help, and to take other effective actions to improve their financial well-being."3 There has been widespread progress in initiatives to improve financial education, based on the principles endorsed by the G-20 leaders. It has been reported that the number of governments that have adopted national strategies for financial education has increased to almost 60. OECD, "Recommendation on Principles and Good Practices for Financial Education and Awareness" (2005). http://www.oecd.org/finance/financial-education/35108560.pdf. B. Importance of Improving Financial Literacy in Japan As part of this global movement, Japan's Financial Services Agency (FSA) and Central Council for Financial Services Information (CCFSI) established the Committee for the Promotion of Financial Education in 2013, and have been strengthening their initiatives to promote financial and economic education.4,5 Let me also mention the government's growth strategy, the Investments for the Future Strategy 2017, approved by the Cabinet in June 2017. The strategy refers to the Nippon Individual Savings Account (NISA), a tax-free small-lot investment program introduced in 2014. It states that, in order to promote households' stable formation of assets, the government will further disseminate and promote the NISA system, including the introduction in January 2018 of the installment-type NISA, and enhance the financial and investment education that leads to improved practical knowledge of investment among households. I believe that it is crucial to improve financial literacy given the situation where many people feel somewhat uncertain about the future. Moreover, as I mentioned earlier, the Bank of Japan aims to achieve the 2 percent price stability target, and in a society where wages and prices rise in a stable manner, financial literacy becomes even more important. Therefore, I believe that the promotion of financial education in Japan is now particularly significant. A number of surveys on financial literacy have been conducted in Japan, with their results revealing many challenges. One such survey is the Financial Literacy Survey conducted in 2016 by the CCFSI. In international comparisons, Japan ranked 24th out of 31 countries and economies in terms of the percentage of correct answers given to common financial questions.6 According to another survey, the percentage of correct answers given to a Since 1950, efforts to encourage voluntary and proactive savings, with the aim of realizing economic autonomy, were led by the Local Councils for Savings Promotion. The Central Council for Savings Promotion was established in 1952 as the focus for private organizations related to this movement. This was then reorganized as the Central Council for Savings Information to concentrate on public relations activities providing accurate knowledge and information regarding the economy, finance, and currency. The council was then renamed as the CCFSI (Secretariat: Public Relations Department, Bank of Japan) in 2001. As suggested by the April 2013 report of the Study Group on Financial Education under the FSA, the Committee for the Promotion of Financial Education (Secretariat: CCFSI) was established to address challenges facing the promotion of financial and economic education. The Financial Literacy Survey is Japan's first large-scale survey covering 25,000 individuals chosen in proportion to Japan's demographic structure. The comparison with overseas was done in question about the meaning of deflation was slightly above 20 percent.7 Obviously, it is no wonder that we face many challenges in financial education, as is the case with education in general. My concern, however, is the possibility that there is not sufficient recognition in Japan of the necessity for financial education in the first place. For example, in a survey of adults conducted in 2016 by the FSA, about 70 percent of respondents answered that they "have not participated in investment education," and about two-thirds of these respondents stated that they "do not wish to acquire financial or investment knowledge." This means that nearly half of all respondents in the survey indicated such unwillingness. My impression is that investment, in particular, is still perceived as something that wealthy people do.8 While this may be partly due to the prolonged period of deflation, I believe it is important that the necessity of financial education gain more recognition in Japanese society. I feel that an increase in such awareness is similar to a rise in public acceptance of a certain degree of increase in prices. It seems to me that both are indicative of a social norm where it is taken for granted that wages and prices rise in a stable manner. terms of the simple average for the percentage of correct answers given to six common questions in the OECD survey, which was conducted in 30 countries and economies in 2016. The multiple-choice question asked: "Which of the statements is correct in times of deflation, where prices continue to decline?" There were three answer choices: (1) "Borrowing is profitable because the value of money increases"; (2) "Borrowing is unprofitable because the value of money increases"; or (3) "Borrowing is unprofitable because the value of money decreases." The survey covered men and women living in Japan, aged from 20 to 69, with 1,000 people providing valid responses to the questions. The results were published in The Nikkei on September 2, 2017. According to the National Survey on Securities Investment conducted in 2015 by the Japan Securities Dealers Association, about 30 percent of respondents answered that securities investment was "something that wealthy people do." The survey was conducted on 7,000 men and women living in Japan who were at least 20 years of age.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 7 December 2017.
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December 7, 2017 Bank of Japan Japan's Economy and Monetary Policy Speech at the Kisaragi-kai Meeting in Tokyo 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 speak at the Kisaragi-kai meeting. The last time I gave a speech at the Kisaragi-kai meeting was early September last year. Two weeks after that, the Bank of Japan conducted a comprehensive assessment of the developments in economic activity and prices as well as of the policy effects under quantitative and qualitative monetary easing (QQE), and decided to introduce a new framework for strengthening monetary easing -- "QQE with Yield Curve Control." While more than a year has passed since then, highly accommodative financial conditions have been maintained in Japan under this framework, and the economy has continued to improve. Today, I would like to first explain the Bank's view on the recent economic and price developments in Japan, and then talk about its thinking behind the conduct of monetary policy. I. The Current Situation of Economic Activity and Its Outlook Overseas Economies Let me start by talking about economic developments. I will first touch on developments in overseas economies. Overseas economies have continued to improve steadily since mid-2016. By region, the U.S. economy has continued to recover firmly, mainly in household spending, owing to improvement in the employment and income situation. The real GDP registered relatively high growth of 3 percent on an annualized quarter-on-quarter basis for the last two quarters, suggesting that the major hurricanes that hit the southern United States in summer only had short-term effects. As for the European economy, although continued attention needs to be paid to negotiations on the United Kingdom's exit from the European Union (EU) and the European debt problem, including the financial sector, the uncertainties surrounding these factors have abated. Under such circumstances, the European economy has continued to recover steadily, and the divergence in growth rates among the euro area economies clearly has become smaller recently. Emerging and commodity-exporting economies have followed their recovery trends. Specifically, the Chinese economy has continued to see stable growth on the whole, partly due to the effects of authorities' measures to support economic activity; commodity-exporting economies such as Brazil and Russia -- which had been stagnant -have picked up, particularly reflecting the bottoming out of commodity prices and monetary easing effects. At the International Monetary Fund's (IMF's) Annual Meeting this October, which I participated in, IMF Managing Director Christine Lagarde assessed the recent global economy as showing "the broadest-based recovery in the last 10 years." With regard to the outlook for the global economy, both the advanced and emerging economies are projected to continue growing in a well-balanced manner. According to the latest World Economic Outlook (WEO) released by the IMF, the global economy is expected to maintain its firm growth, with the annual real GDP growth rate registering 3.2 percent in 2016, 3.6 percent in 2017, and 3.7 percent in 2018 (Chart 1). The Current Situation of Japan's Economic Activity and Its Outlook Next, I will talk about Japan's economy. It has continued to grow in a well-balanced manner, similar to the case I just mentioned for the global economy. Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. The real GDP growth rate for the July-September quarter was 1.4 percent on an annualized basis, representing positive growth for the seventh consecutive quarter. This was observed for the first time in 16 years, since 2001. The output gap that shows the utilization of capital and labor exceeded the long-term average of 0 percent in the second half of 2016, and has widened further in positive territory recently (Chart 2). This is the third time in the past 20 years that Japan's output gap turned positive. The past two cases occurred during the so-called dot-com bubble period in the early 2000s and the global credit bubble period from 2006 through 2008. Both of these recovery phases depended on external demand. By contrast, in the current recovery phase, both the external and domestic demand are strong drivers for Japan's economic growth. As for external demand, Japan's exports have increased -- mainly led by IT-related goods exported to Asia -- on the back of the growth in overseas economies. In addition, domestic demand has been on an increasing trend. Specifically, business fixed investment has been on a moderate increasing trend, while corporate profits have improved, marking record high levels (Chart 3). Private consumption has increased its resilience, supported by steady improvement in the employment and income situation as well as replacement demand for durable goods. Public investment also has been increasing due to the implementation of the government's stimulus measures formulated in fiscal 2016. As these developments show, Japan's current economy is supported by multiple factors -- namely, external demand, domestic private demand, and domestic public demand -- in a well-balanced manner. For this reason, it is possible to assess the economy as having resilience to exogenous shocks. Another notable feature of Japan's economy recently is that the effects of its expansion have been spreading to a wide range of economic entities. The diffusion index (DI) for business conditions in the Tankan (Short-Term Economic Survey of Enterprises in Japan) has continued to be positive, not only in large enterprises and manufacturers but also in small enterprises and nonmanufacturers. This is clearly different from the recovery phases in the early and mid-2000s, which were led by external demand (Chart 4). Looking at developments by region, the DI has been positive for all regions since the December 2013 survey. Labor market conditions have tightened nationwide, as seen in the active job openings-to-applicants ratios in many regions having risen to levels comparable to those in major metropolitan areas (Chart 5). Let me turn to the economic outlook. Going forward, Japan's economy is expected to continue expanding moderately. The Bank makes projections for Japan's economic activity and releases them quarterly in the Outlook for Economic Activity and Prices (Outlook Report); in the latest Outlook Report released at end-October, the medians of the Policy Board members' forecasts of the real GDP growth rates for fiscal 2017 and 2018 are 1.9 percent and 1.4 percent, respectively. These figures are above Japan's potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. In fiscal 2019, although the growth pace is projected to decelerate, the economy is expected to continue expanding, underpinned by the increase in exports on the back of the growth in overseas economies, and the median of the forecasts of the real GDP growth rate is 0.7 percent. The economic activity could, of course, deviate either upward or downward from these projections. The biggest risk factor is developments in overseas economies. As I mentioned earlier, the baseline scenario is that overseas economies are expected to continue growing at a moderate pace, and it is no longer the case that risks are likely to be skewed to the downside. That being said, the U.S. economic policies and their impact on global financial markets warrant attention, and geopolitical risks also could exert downward pressure on economic activity. The Bank will continue to pay close attention to both upside and downside risks. II. Price Developments and Their Outlook Price Developments Now, I will move on to price developments. Prices in Japan have been increasing gradually, mainly on the back of a rise in energy prices. The year-on-year rate of increase in the consumer price index (CPI) excluding fresh food has accelerated to 0.8 percent this October, rising by more than 1 percentage point in a year from the rate of change of minus 0.4 percent registered in October last year (Chart 6). Excluding the effects of energy prices, however, the rate of change in the CPI has remained slightly positive. Thus, price developments in Japan are still relatively weak despite continuing economic expansion and the tightened labor market conditions. Somewhat strong economic activity and relatively weak prices, which seem contrary to each other at first glance, are coexisting in Japan. This situation is also observed in other advanced economies recently. The inflation rates in the United States and the euro area have remained below the central banks' target levels despite the firm improvement in the global economy that I mentioned at the outset. Federal Reserve Chair Janet Yellen described the recent sluggish price developments in the United States as a "mystery," while referring to the possibility that such developments are mainly due to transitory factors such as a decline in telecommunication service prices. The chair pointed out that the outlook is subject to considerable uncertainty from multiple sources. Specifically, in addition to uncertainties regarding the supply capacity in the labor market and medium- to long-term inflation expectations, the chair mentioned the possibility that factors such as increasing competition with emerging economies, reflecting globalization, and a rapid spread of the use of online shopping backed by advances in technology could affect price developments. It may be very beneficial for Japan as well to consider these points when analyzing its price developments. However, it also should be kept in mind that the inflation rates in the United States and the euro area have been at around 1.5 percent despite being regarded as somewhat weak, and that such situation is somewhat different from that in Japan. Therefore, it is natural to think that low inflation in Japan also is attributable to factors that are unique to Japan. The Background to Relatively Weak Price Developments and Their Outlook I will elaborate on the relationship between economic activity and prices in Japan. Taking into account that firms' wage- and price-setting stance exerts a large impact on prices, weakness in price developments in Japan can be explained by the following two steps. The first is a moderate improvement in wages despite the tightness in labor market conditions. In particular, it is noticeable that wage increases for full-time employees are sluggish, compared to those for part-time employees (Chart 7). Since scheduled cash earnings of full-time employees account for almost 70 percent of the total employee income, their impact is not small. On this issue, some point to the fact that, since both labor and management in Japan place priority on the long-term stability of employment and wages over wage increases, the following has been observed: employment adjustment and wage reductions of full-time employees had been conducted only marginally in an economic downturn, and wages barely rise even if the economy recovers and labor market conditions tighten. It also can be said that past downward rigidity in wages has led to the present upward rigidity. The second is that, even though wage increases have been taking place, albeit at a moderate pace, the pass-through of wage costs to sales prices has not been observed yet widely. This reflects firms' efforts to absorb increased wage costs through, for example, labor-saving investment that makes use of information technology, as evident in software investment increasing remarkably of late in industries where labor shortage is particularly acute, such as restaurants, retail, and construction (Chart 8). While these efforts are based on individual firms' reasonable business strategy with a view to raising productivity, they would reduce the upward pressure on prices in the economy as a whole. However, I believe that this situation is changing gradually. First of all, we will see a change in wages. Given that the labor market conditions have been so tight, it is no wonder that this leads to an increase in wages for full-time employees. It also is an important fact that a base pay rise, which did not take place under deflation, has continued for four consecutive years since 2014. In order to create a virtuous cycle between a moderate rise in prices and increases in corporate profits and income, it should be widely recognized in society that wages rise continuously under a sound economy. The Bank expects that efforts by both labor and management to realize the virtuous cycle will become widespread by taking advantage of tailwinds of the current favorable economic environment. In addition, firms' stance is likely to gradually shift toward raising prices. With hourly scheduled cash earnings of part-time employees remaining on an uptrend, the upward pressure of the rise in firms' costs on prices has been increasing, supported also by a rise in input prices due to the past depreciation of the yen. It seems that consumers are gradually accepting price rises on the back of the employment and income situation having been improving. Although, for the time being, it is likely that some firms will decide on a price rise while others will remain hesitant, firms' bullish stance to raise prices is expected to become predominant eventually. However, it is not easy to clearly point to the timing of when this will happen beforehand, because the specific timing at which each firm's stance shifts toward raising prices is likely to vary, depending on developments in demand that each firm and industry faces, or on the cost structure. The CPI, which reflects these developments, is likely to increase moderately going forward. III. QQE and Its Effects Basic Mechanism of Monetary Easing So far, I have explained developments in Japan's economic activity and prices. In what follows, I will talk about the Bank's conduct of monetary policy. In textbook theory, the basic mechanism of monetary policy is to stimulate or contain economic activity by driving the actual real interest rates to levels below or above the natural rate of interest, which I will explain shortly. Real interest rates are rates adjusted to exclude future price fluctuations by subtracting inflation expectations from the nominal interest rates that we usually come across. The natural rate of interest is the real interest rate at which the economy neither accelerates nor decelerates, and is likely to be close to the potential growth rate under normal conditions. The lower the actual real interest rates than the natural rate of interest, the greater the level of monetary accommodation. The economic growth will accelerate as low interest rates stimulate economic activities such as business fixed investment, leading to an improvement in the output gap. This improvement will finally bring about a rise in the inflation rate. QQE, which the Bank introduced in April 2013, aims to substantially lower Japan's real interest rates in order to overcome deflation that lasted for the past 15 years. In September last year, the Bank introduced a new framework -- "QQE with Yield Curve Control" -thereby further strengthening monetary easing. This framework consists of two components that aim at lowering real interest rates (Chart 9). The first 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 actual CPI exceeds 2 percent and stays above that level in a stable manner. It aims to raise people's inflation expectations in a more forceful manner. The second component is yield curve control. The Bank conducts large-scale purchases of Japanese government bonds (JGBs) to facilitate the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent at the earliest possible time. Specifically, 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 zero percent, and the observed yield curve has been formed smoothly in a manner consistent with this guideline. If the Bank maintains nominal interest rates at sufficiently low levels through yield curve control and raises people's inflation expectations through the inflation-overshooting commitment, real interest rates -- calculated by subtracting inflation expectations from nominal interest rates -- will decline significantly. Yield Curve Control Now, I would like to provide a little more explanation concerning the second component, yield curve control. Before introducing this framework in September last year, the Bank set a quantitative target -- increasing the outstanding amount of JGBs held by the Bank at an annual pace of about 80 trillion yen -- and was purchasing JGBs in line with the target. There are commonalities and differences between the previous approach and the current yield curve control approach. First, these two approaches are the same in terms of the basic transmission mechanism of monetary easing: lowering nominal interest rates through large-scale JGB purchases and thereby reducing real interest rates. However, under the previous approach, which fixed the purchase amount of JGBs at a certain level, the level of interest rates could decline either excessively or insufficiently, reflecting the economic and price developments as well as the conditions in the JGB market. As a result, the yield curve could deviate either upward or downward from the one that the Bank deemed appropriate. This problem does not arise in principle under the current yield curve control because it sets the short- and long-term interest rates themselves as operating targets. Indeed, as I mentioned earlier, the yield curve in Japan has been formed smoothly in a manner consistent with the guideline for market operations in the past one year. There are several points to make in conducting yield curve control. The first point is how to determine the most appropriate shape of the yield curve to achieve the price stability target of 2 percent. Under conventional monetary policy, determining one optimal short-term policy interest rate -- the uncollateralized overnight call rate, for example -- was sufficient in conducting monetary policy. However, under the current framework, we naturally must extend the scope to the entire yield curve. It is necessary to analyze the status of inflation expectations and the natural rate of interest for each maturity and find the shape of the yield curve that produces the most appropriate level of monetary accommodation. Although this process involves difficult analysis in practice, the basic concept is clear. As we explained in the Comprehensive Assessment, in order to form an appropriate yield curve, the Bank makes decisions in consideration of the possible spillover effects on bank lending rates and issuance rates for corporate bonds, the impact on the economy, and the impact on the functioning of financial intermediation, among other factors. The Bank has maintained this stance ever since introducing yield curve control in September last year. The second point is the sustainability of yield curve control. I am aware of concerns among some market participants that, as the Bank continues to purchase JGBs on such a large scale, the supply of JGBs circulating in the market may dry up sooner or later, making it difficult to control the long-term interest rate. In this respect, the Bank's JGB purchases have been conducted in a smooth manner thus far and the Bank expects that the risk of having a problem in terms of continuing with its JGB purchases will be small for the time being. Of course, controlling the long-term interest rate itself is a challenging initiative that is unprecedented in global terms. To keep the long-term interest rate under control, it is necessary to have a firm understanding of what factors affect the interest rate for each maturity. Analysis on this point has been conducted not only by the Bank of Japan but also by the Federal Reserve and the European Central Bank (ECB), which have also implemented large-scale asset purchase programs. Although there are various approaches to analyzing what factor affects the long-term interest rate, the prevailing view appears to be that what has a strong impact in the long run is not the purchase amount of government bonds by a central bank in each market operation on a flow basis. Rather, the long-term interest rate is largely influenced by the amount outstanding of government bonds purchased by the central bank on a stock basis, which represents the cumulative net purchase amount of government bonds, or the ratio of the amount outstanding of the central bank's holdings of government bonds to the overall amount issued. The Bank assesses that the main reason it has been able to maintain the 10-year JGB yields at around 0 percent since the introduction of yield curve control is stock effects -- or the cumulative effects of JGB purchases that have continued since before its introduction -- which have been working well. With stock effects working firmly, if the supply-demand conditions in the JGB market tighten in the future, the impact of a unit amount of the Bank's 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. Therefore, I would like to reemphasize that yield curve control is designed to be highly sustainable. Accommodative Financial Conditions Lastly, I will discuss the actual effects of the Bank's monetary easing measures on Japan's economy. Through the introduction of QQE, the Bank has succeeded in lowering Japan's real interest rates well below the potential growth rate by conducting large-scale JGB purchases and raising inflation expectations (Chart 10). This was the first such achievement to be made in the fight against prolonged deflation since the end of the 1990s. As a consequence, the economic activities of firms and households have been activated, leading to a steady improvement in the output gap. According to the government, the current recovery phase, which started in December 2012, is highly likely to have lasted for 58 consecutive months by September this year. The duration of the current recovery has thus surpassed that of the Izanagi Boom in the second half of the 1960s. In light of this situation, coupled with the fact that the period of the current recovery mostly overlaps the period of QQE, it appears that this policy has contributed to the long-lasting recovery, which is the second longest in the post-war era. On the price front, too, annual CPI inflation excluding fresh food and energy has been positive as a trend for about four years. Under QQE, Japan is no longer in deflation, which is generally defined as a sustained decline in prices. It seems that the monetary easing has exerted positive effects on individual firms in the form of improvement in funding conditions. In line with the decline in JGB yields, which are the base interest rates, firms' funding costs -- namely, bank lending rates and issuance rates for CP and corporate bonds -- have declined firmly. For example, bank lending rates on new loans recently have been around historical low levels, in the range of 0.5-1.0 percent. The real bank lending rates -- the nominal bank lending rates minus the inflation rates -- on new loans have declined to around 0 percent (Chart 11). In other words, the average firm can borrow new loans with hardly any interest payment if the inflation rates are taken into consideration. Also, with respect to the availability of funds, many firms have the growing sense that financial conditions have become highly accommodative. From the viewpoint of either large or small enterprises, the lending attitudes of financial institutions have become very proactive. In terms of the DI in the Bank's Tankan for lending attitudes, that for small enterprises in particular has been at a high level last seen at the end of the 1980s (Chart 12). The Bank will continue to provide maximum support for corporate activities in Japan by maintaining such accommodative financial conditions. Conclusion Today, I have explained the recent economic and price developments and the Bank's thinking behind the conduct of monetary policy that takes account of such developments. Although it is true that there is still a long way to go to achieve the price stability target of 2 percent, it is clear from the results so far achieved that QQE has been effective in drastically improving Japan's economy. Going forward, in line with the steady improvement in the economy, firms' stance is likely to gradually shift toward raising wages and prices. Moreover, people's medium- to long-term inflation expectations are projected to rise steadily as further price rises come to be observed widely. In order to ensure that such positive developments will be long-lasting and that Japan's economy will become a well-balanced one in which economic improvement and price stability are simultaneously achieved, the Bank will continue to persistently pursue powerful monetary easing under the current framework of "QQE with Yield Curve Control" with a view to achieving the price stability target of 2 percent. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at the Kisaragi-kai Meeting in Tokyo December 7, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Global Economy Projections of Real GDP Growth by Major Economies (as of October 2017) Global Real GDP Growth y/y % chg. y/y % chg. IMF projection World 3.4 3.2 Advanced economies 2.2 1.7 United States 2.9 1.5 Euro area 2.0 1.8 Japan 1.1 1.0 4.3 4.3 China 6.9 6.7 ASEAN 5 4.9 4.9 Emerging market and developing economies -1 CY 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 Note: Figures in parentheses in the right figure show differences from the projections as of July 2017 (% points). Source: IMF. [Projection] [Projection] 3.6 3.7 (＋0.1) (＋0.1) 2.2 2.0 (＋0.2) (＋0.1) 2.2 2.3 (＋0.1) (＋0.2) 2.1 1.9 (＋0.2) (＋0.2) 1.5 0.7 (＋0.2) (＋0.1) 4.6 4.9 (0.0) (＋0.1) 6.8 6.5 (＋0.1) (＋0.1) 5.2 5.2 (＋0.1) (0.0) Chart 2 Economic Recovery in Japan Real GDP Output Gap s.a., ann., tril. yen % -2 -4 -6 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 -8 CY00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for output gap are based on BOJ staff estimations. Sources: Cabinet Office; Bank of Japan. Chart 3 Domestic Demand Corporate Profits and Business Fixed Investment s.a., % s.a., ann., tril. yen Private Consumption s.a., CY 2010＝100 CY05 06 07 08 09 10 11 12 13 14 15 16 17 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Ratio of current profits to sales (all industries and enterprises, left scale) Private nonresidential investment (SNA, real, right scale) Consumption Activity Index (travel balance adjusted, real) Notes: 1. Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." 2. Figures for private consumption are based on BOJ staff calculations. Figures exclude inbound tourism consumption and include outbound tourism consumption. Sources: Ministry of Finance; Cabinet Office; Bank of Japan. Chart 4 Business Conditions DI (Tankan) By Region By Firm Size DI ("favorable" - "unfavorable"), % points DI ("favorable" - "unfavorable"), % points "Favorable" "Favorable" 10 "Unfavorable" -10 -10 -20 -20 -30 -30 Large enterprises -40 Range of responses by region -40 Medium-sized enterprises -50 "Unfavorable" Japan (all industries and enterprises) -50 Small enterprises -60 CY 05 -60 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 14 15 16 17 Source: Bank of Japan. Chart 5 Employment Situation Active Job Openings-to-Applicants Ratio by Region 2.0 s.a., ratio Range of the active job openings-to-applicants ratios by region 1.8 Japan 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 CY 00 Sources: Ministry of Health, Labour and Welfare; Bank of Japan. Chart 6 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 7 Income Situation Wages of Full-Time and Part-Time Employees 3.5 y/y % chg. 3.0 Scheduled cash earnings (full-time employees) 2.5 Hourly scheduled cash earnings (part-time employees) 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Note: Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. The figure for 2017/Q3 is that for September. Source: Ministry of Health, Labour and Welfare. Chart 8 Firms' Efforts to Address Labor Shortage Employment Conditions DI (Tankan) -80 reversed, DI ("excessive" - "insufficient"), % points All industries -60 Software Investment (Tankan) FY 2005 = 100 All industries Accommodations, eating & drinking services Accommodations, eating & drinking services Construction Construction Retailing -40 Retailing "Insufficient" -20 "Excessive" CY 05 06 07 08 09 10 11 12 13 14 15 16 17 FY 05 Note: Figures for the software investment plans for fiscal 2017 are forecasts from the September 2017 Tankan survey. Source: Bank of Japan. Chart 9 QQE with Yield Curve Control Yield Curve Control Inflation-Overshooting Commitment Inflation rate 1.2 % JGB yield curve 1.0 0.8 2% 0.6 0.4 Short-term policy interest rate "minus 0.1 percent" Target level of the long-term interest rate "around zero percent" 0.2 0.0 -0.2 -0.4 Expansion of monetary base continues Source: Bloomberg. 0 1 2 3 4 5 6 7 8 9 10 15 20 year residual maturity Chart 10 Long-Term Real Interest Rate % Introduction of QQE Potential growth rate -1 Long-term real interest rate (10-year JGB yields minus inflation expectations < 6-10 years ahead>) -2 FY 95 Notes: 1. Figures for inflation expectations (y/y, ann. avg., %) are from the "Consensus Forecasts." Those for the potential growth rate (y/y % chg.) are based on BOJ staff estimations. 2. Figures for fiscal 2017 are those for 2017/Q2. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bloomberg; Bank of Japan. Chart 11 Bank Lending Rate % Real bank lending rate (bank lending rate minus the CPI <all items less fresh food>) Potential growth rate -1 FY 83 84 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 17 Notes: 1. Figures for the bank lending rate are the average contract interest rate on new loans and discounts (total). The CPI figures (y/y % chg.) are adjusted for changes in the consumption tax rate. Figures for the potential growth rate (y/y % chg.) are based on BOJ staff estimations. 2. Figures for fiscal 2017 are those for 2017/Q2. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 12 Corporate Finance Lending Attitude of Financial Institutions (Tankan) DI ("accommodative" - "severe"), % points Large enterprises Small enterprises -10 -20 -30 -40 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 17 Note: There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: 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 2017.
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December 26, 2017 Bank of Japan Overcoming Labor Shortages: Prospects for Sustainable Economic Growth 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. The year has flown by, and 2018 is now just a week away. Today, to round off 2017, I would like to take a look back at this year's economic developments both at home and abroad, and elaborate on Japan's current economic recovery phase -- the second longest in the post-war era -- while making comparisons with past recovery phases, focusing in particular on labor shortages and firms' efforts to overcome them. I would then like to explain the Bank of Japan's conduct of monetary policy and close my speech by sharing my hopes for Japan's economy in the coming year. I. The Global Economy in a New Phase I will start by talking about the global economy. At this meeting last year, I mentioned that the global economy at the time was entering a new phase by putting the negative legacy of the global financial crisis behind it. In fact, from a somewhat longer-term perspective, the global economy seems to have reached a turning point this year after having been subdued since the global financial crisis in 2008. Let me take the example of developments in world trade (Chart 1). After the global financial crisis, growth of the world trade volume -- calculated by adding up the import volumes of economies worldwide -- was slower than global economic growth. This deceleration in the growth of the world trade volume has been referred to as "slow trade." Production activities in the manufacturing sector, which are closely linked to world trade, were subdued as well. However, this trend has been changing from the second half of 2016 to this year. Partly due to the substantial progress in inventory adjustments mainly in emerging economies, trade in goods such as materials, IT-related goods, and capital goods has become active recently and the world trade volume has been growing at a faster pace than the global economy again. Accordingly, business sentiment in the manufacturing sector on a global basis hit bottom in the first half of 2016 and improved markedly this year. Given that the growth rates of both advanced and emerging economies have been rising moderately, the global economy has been growing in a well-balanced manner. Going forward, the global economy is expected to continue growing at a moderate pace. In the World Economic Outlook (WEO) released by the International Monetary Fund (IMF), growth projections have continued to be revised upward, and both advanced and emerging economies are expected to maintain their firm growth through next year. At international conferences I have recently attended, a frequently used phrase has been "synchronous growth" of the global economy. At those conferences, participants from various economies all looked brighter than they used to, which has given me the strong impression that the global economy has entered a new stage. II. Economic Developments in Japan: Long-Lasting Recovery Next, I will touch upon developments in Japan's economy. The economy has improved steadily this year, backed in part by the developments in the global economy that I just outlined. Real GDP for the July-September quarter registered relatively high growth of 2.5 percent on an annualized basis, representing positive growth for the seventh consecutive quarter since the January-March quarter of 2016. In detail, Japan's exports have been on an increasing trend, mainly led by IT-related goods exports to Asia. Domestic demand has also increased. Specifically, business fixed investment has continued on an increasing trend with corporate profits improving. Private consumption has been increasing moderately, albeit with fluctuations, against the background of steady improvement in the employment and income situation. Public investment also has remained at a relatively high level due in part to the implementation of the government's stimulus measures formulated in fiscal 2016. As these developments show, Japan's economy is currently expanding moderately in a well-balanced manner, supported by multiple factors -- namely, external demand, domestic private demand, and domestic public demand. Another salient feature of Japan's recent economy is that the benefits of the economic expansion have been spreading to a wide range of economic entities. According to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion indexes (DIs) for business conditions have continued to be positive, not only for large enterprises and manufacturers but also for small enterprises and nonmanufacturers (Chart 2). Also, by region, the DIs have improved significantly for all regions. The current economic recovery is also characterized by its long duration. The duration of the current recovery phase, which started in December 2012, likely reached 60 consecutive months in November 2017 (Chart 3). This exceeds the 57 months of the Izanagi boom, which occurred in the midst of the period of high economic growth, and is the second longest boom in the post-war era. In the post-war era, the longest recovery phase is that from 2002 through 2008, followed by the current one as the second, the Izanagi boom from 1965 through 1970 as the third, and the Heisei boom from 1986 through 1991 as the fourth. Each of the four recovery phases that I just mentioned has its own particular characteristics. During the Izanagi boom, for example, the economy achieved annual growth of more than 10 percent on average amid a steadily increasing population and under the slogan "catch up with and overtake" the U.S. and European economies. Growth expectations at that time differed substantially from those today. The Heisei boom more or less coincided with the so-called bubble period, when the expectations of a wide range of economic entities turned excessively bullish and, as a result, investment and consumption activity became overheated. These phases have similarities as well. One notable similarity is that all four phases witnessed a tighter labor market than the periods before and after them. This past experience offers valuable insights into how the current acute labor shortages may affect wages and prices. More specifically, the experience of the past three recovery phases can provide us with important clues as to how the current labor shortages could transform Japan's economy going forward. In what follows, I would like to take a look back at these past phases in more detail. III. Labor Shortages, Wages, Prices, and Productivity: Past Experience and Implications for the Present Past Experience Before comparing the current recovery phase with those in the past, I would like to first provide a theoretical introduction. Firms that face increases in costs due to wage increases stemming from labor shortages will generally consider the following two options. One is to pass on the increase in wage costs to the sales prices of their products and services with a view to securing profits. The other is to undertake labor-saving investment and streamline production and sales processes in response to labor shortages, and thereby provide a larger amount of products and services with the same number of employees. This allows firms to secure profits without passing on increases in wage costs to sales prices. For example, if hourly wages of employees double due to labor shortages, firms will still be able to maintain the same level of profitability without raising the prices of their products if they introduce new production facilities that enable employees to produce twice as much per employee as before. From a macroeconomic perspective, increases in firms' sales prices will lead to a rise in the general price level, while improvements in the efficiency of individual firms' production and sales processes will lead to higher productivity in the economy as a whole. Increases in nominal wages caused by labor shortages can be decomposed into two components: the part that is passed on to general prices and the rest, which is absorbed by the increase in labor productivity. Put differently, if we subtract the increase in prices from the increase in nominal wages, the remainder will reflect the increase in productivity. This corresponds to the rise in real wages, which represents an increase in households' real income. This raises households' purchasing power, stimulating private consumption, which in turn will spur new investment by firms through a rise in corporate profits. In this manner, the mechanism will start to operate by which increases in wages create a virtuous cycle from income to spending and encourage further economic expansion. As mentioned earlier, in each of the four recovery phases, including the current one, labor market conditions tightened or have tightened. However, the specific degree to which labor market conditions tightened differs by phase (Chart 4). During the recovery phase in the mid-2000s, the active job openings-to-applicants ratio rose only to around 1, which was insufficient to trigger the virtuous cycle just mentioned. Under these circumstances, upward pressure on wages was limited, so that deflation continued and private consumption remained subdued. Despite being the longest in the post-war era, the economic recovery in the mid-2000s seems to have not been self-sustaining, but relied on external demand and, more specifically, the credit bubble in the United States fuelling that demand. In contrast, during the Izanagi and Heisei booms, when the active job openings-to-applicants ratio increased nearly to 1.5 -- almost the same level as today -- and labor shortages became acute, wages increased and the virtuous cycle described earlier firmly took hold. I would now like to take a close look at developments in each of these phases. Let me start with the Izanagi boom. During this period, the active job openings-to-applicants ratio increased to 1.49, which is very similar to the level today. Economic history textbooks as well as writings at the time suggest that, with wages rising due to acute labor shortages, firms simultaneously pursued the two options just described; that is, they passed on the increased costs to sales prices, and they improved production efficiency (Chart 5). The degree of pass-through to sales prices depended on individual firms and the industry to which they belonged. Since small firms in the service sector such as Japanese-style inns and barbershops, for instance, were so labor intensive that they could not absorb increases in wage costs through the streamlining of business processes and improvements in efficiency, they more or less fully passed on the increases in wage costs to services prices. According to statistics of the time, the cost of a haircut increased at an average annual rate of 10 percent during this period. On the other hand, faced with acute labor shortages, many small and medium-sized firms especially in the manufacturing sector actively invested in new facilities and equipment to improve efficiency. Such investment was also stimulated by the growth of processing and assembly industries, such as electric machinery and automobiles, which involved many manufacturing firms. For a certain period after the end of World War II, there was a significant productivity gap, called the "dual structure," between large firms with high capital intensity and small firms with low capital intensity. However, the gap narrowed significantly during the Izanagi boom, when small and medium-sized manufacturing firms actively invested in facilities and equipment. In this way, not only did prices rise, but firms' efforts to raise productivity also drastically intensified. As a result, real wages increased notably, thereby substantially boosting households' purchasing power. It is during this period that the penetration of durable goods such as private cars, color TV sets, and air conditioners -- the so-called "3Cs" -- increased rapidly. Furthermore, the surge in private consumption encouraged firms to undertake more investment aimed at producing higher value-added products. Literally, with wages and prices increasing, a virtuous cycle from income to spending was in place. A similar mechanism operated in the Heisei boom, which started from 1986 (Chart 6). Amid an increase in the active job openings-to-applicants ratio to nearly 1.5, the annual growth rate of scheduled wages rose to around 4 percent. Since part of the increase in wage costs was passed on to prices of products and services, the annual price inflation rate rose to around 3 percent. While it needs to be taken into account that expectations at the time were excessively bullish, firms increased fixed investment, boosting labor productivity. Manufacturing firms proactively introduced new technologies such as micro-electronic equipment, including robots, and nonmanufacturing firms made efforts to streamline administrative work through office automation. As a result, real wages increased, raising households' purchasing power. Many of you may remember the consumer boom at that time, leading to proactive investment by firms. Implications for the Current Recovery Phase Based on the experience of the past, I would like to explore wage and price developments as well as firms' efforts to raise productivity in the current recovery phase. Let me start with wage developments. The year-on-year rate of increase in hourly wages of part-time employees, which are particularly sensitive to labor market conditions, has accelerated to the range of 2.0-3.0 percent. For full-time employees, base pay at many firms has increased for four consecutive years, suggesting that upward pressure on wages has been gradually but steadily increasing (Chart 7). That being said, it cannot be denied that, relative to the strength of the economy and degree of labor market tightening, the pace of increase in wages is more sluggish than in past recovery phases. While there may be many reasons for this, it seems that the 15 years of deflation are still greatly affecting the economy today, particularly with regard to the weak developments in wages. In Japan, wages of full-time employees are said to be not very sensitive to developments in labor market conditions. While the return of base pay increases signals an important improvement in the wage situation, firms' wage-setting stance has remained cautious on the whole. Some have argued that, reflecting that both labor and management in Japan place priority on the long-term stability of employment and wages over wage increases, firms avoided large-scale layoffs and wage cuts under deflation, so that firms cannot simply switch to increasing wages even when the economy grows and labor market conditions tighten. Next, I will talk about developments in prices and productivity. As I just mentioned, wages have been increasing gradually, albeit at a slower pace than in the past. Under these circumstances, it seems that many firms so far have been making efforts to raise their labor productivity and absorb increases in wage costs rather than raising their sales prices. For instance, a wide range of firms mainly in the nonmanufacturing sector have recently been proactively undertaking labor-saving and efficiency-improving investment. The software investment plans for this fiscal year of some industries such as construction, retailing, as well as accommodations and restaurants showed significant increases compared to the actual investment made last year. Meanwhile, specific examples of labor-saving and efficiency-improving investment include hotels and Japanese-style inns using artificial intelligence (AI) or robots to take care of their customers, construction firms introducing drones at construction sites, and transportation firms halving the number of workers at warehouses by building automated ones. In contrast to such efforts to raise productivity, moves to pass on increases in wage costs to sales prices have lacked sufficient strength on the whole, since so far such moves have been only observed at some firms in labor-intensive industries and industries with a high ratio of part-time employees, such as transport and dining-out. The experience of prolonged deflation again plays a major role; with consumers remaining reluctant to accept price rises, many firms are concerned about losing customers if they raise prices. It seems so difficult for many firms to take the first step to raise their prices that they wait and see what other firms are doing. In sum, during the current recovery phase, we have seen the mechanism in place by which labor shortages exert upward pressure on wages, which encourages firms to raise sales prices and work toward raising labor productivity. In this regard, the current recovery is more like the Izanagi and Heisei booms rather than the recovery in the mid-2000s. But at the same time, the mechanism is weaker so far in the current phase than in those two phases. In particular, it has been taking time for firms' stance to shift toward increasing wages and prices despite acute labor shortages. Nevertheless, economic conditions supportive to wage growth are clearly being put in place. The active job openings-to-applicants ratio already exceeds the peak levels of the Izanagi and Heisei booms and the unemployment rate is now firmly below 3 percent, suggesting that Japan's economy is virtually at full employment. Corporate profits are at record high levels, substantially exceeding the levels of the past recovery phases (Chart 8). Going forward, supported by highly accommodative financial conditions, the economy is likely to continue expanding firmly with labor market conditions tightening further. It is expected that this will reinforce the mechanism by which prices and labor productivity rise along with wages, encouraging households and firms to increase expenditures. If this takes place, the economy will continue to expand in a more sustainable manner. Let me add one important thing. Although I made various comparisons to the Izanagi and Heisei booms, there is one notable difference between these two booms. The Izanagi boom helped to form a large middle class, leading to a situation in which almost all Japanese felt that they belonged to the middle class, and provided the basis for subsequent stable and sustainable economic growth. In contrast, the economic growth of the Heisei boom proved to be unsustainable. While the economy saw high wage growth and moderate price rises, the boom also gave rise to an asset bubble, the burst of which brought about the prolonged stagnation observed through the 2000s. In the current recovery phase, although no signs of excessively bullish expectations are observed in asset markets and financial institutions' behavior so far, developments in financial conditions also continue to warrant close attention. IV. The Bank's Conduct of Monetary Policy Next, I will explain the Bank's conduct of monetary policy. With the aim of achieving the price stability target of 2 percent, the Bank has continued with powerful monetary easing since the introduction of quantitative and qualitative monetary easing (QQE) in April 2013. To strengthen it further, the Bank introduced a new framework of "QQE with Yield Curve Control" last September. I am convinced that the series of powerful monetary easing measures has made a substantial contribution to the current 60-month-long recovery phase that I talked about. On the price front, the annual CPI inflation excluding fresh food and energy has been positive as a trend for about four years since October 2013 (Chart 9). This is the first time since the end of the 1990s that such a development has been observed in Japan. Japan's economy is no longer in deflation, which is generally defined as a sustained decline in prices. As I mentioned earlier, however, price developments in Japan have remained relatively sluggish compared to the economic expansion and the labor market tightening. Annual CPI inflation excluding fresh food and energy has remained only slightly positive, and there is still a long way to go to achieve the price stability target of 2 percent. Given this situation, the Bank will continue to persistently pursue powerful monetary easing under the current "QQE with Yield Curve Control," thereby more firmly supporting the mechanism in which the virtuous cycle from income to spending continues to operate, with wages and prices increasing moderately. V. Overcoming Labor Shortages: Hopes for the New Phase Given that there is little time left, I would like to conclude my speech. Today, I have taken a look back at past economic recovery phases and pointed out that the shortage of labor can give rise to increases in wages and prices, leading to a virtuous cycle in the economy. I am also aware that labor shortages are a major management issue that individual firms have been trying to address. In fact, it has been reported at the quarterly meetings of general managers of the Bank's branches that some firms have had to decline orders from customers due to labor shortages. Moreover, some have raised the concern that the acute labor shortages may constrain Japan's economic growth. However, I do not share this pessimistic view. The past recovery phases that I talked about today provide grounds for my stance. Past experience shows that in the process of overcoming labor shortages, Japan's economy boosted its growth potential through individual firms' efforts to raise their productivity. Labor shortages are only one example, and Japan's economy has repeatedly proved that something that initially was considered as a constraint on economic growth turned out actually not to be a constraint, but rather something that led the economy into a new phase. When Japan was hit by the two oil shocks in the 1970s, there were concerns that natural resource shortages would constrain Japan's economic growth and pessimistic views that Japan's economic growth rate would fall to zero prevailed. The reality was that proactive energy-saving investment by many firms made Japan's economy the most energy-efficient economy in the world, enabling it to overcome the challenges posed by the jump in oil prices. More recently, after the Great East Japan Earthquake, a concern was that electric power supply shortages and supply chain disruptions could be a major constraint on economic activity. However, many firms recovered their production capacity remarkably quickly by increasing in-house power generation facilities and rebuilding or relocating production sites. As these examples indicate, the economy can grow by overcoming what in the short run are considered as constraints. A driver of overcoming such constraints has always been individual firms' proactive efforts. I am convinced that this is also the case with the current labor shortages. I have full confidence in the problem-solving abilities of Japanese firms. While many firms have already started to address labor shortages through fixed investment and other measures, it is important for firms to take full advantage of business opportunities by staying ahead of their competitors, with a view to deploying their available human resources effectively. In order for firms to further raise their growth potential, they also need to secure talented human capital by paying the appropriate wages. Under deflation, taking a step ahead of others may have seemed risky and the best option may have been to wait patiently, but this situation has already changed. There are some firms that have shaken off the deflationary mindset and have proactively embarked on new initiatives. When more firms follow suit, this will give rise to a virtuous cycle in the economy as a whole, with prices rising moderately as wages and productivity increase, leading to sustainable economic growth. I sincerely hope that the year 2018 will be a wonderful one for all of you, and that you will overcome the challenges posed by labor shortages, helping Japan's economy to enter a new phase. The Bank will continue to provide you with the maximum support in our role as the central bank. Thank you for your attention. Overcoming Labor Shortages: Prospects for Sustainable Economic Growth Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo December 26, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Global Economy World Trade Volume and Real GDP of the Global Economy Projections for Global Real GDP Growth y/y % chg. y/y % chg. IMF projection -5 -10 -15 Trade volume Real GDP -1 World output -2 Advanced economies -3 -4 -20 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Emerging market and developing economies -5 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. Figures for the trade volume are those for real imports. The figure for 2017/Q4 is that for October. 2. Real GDP of the world economy in the left chart is based on BOJ staff calculations using PPP-adjusted GDP shares of world total GDP from the IMF as weights. Sources: CPB Netherlands Bureau for Economic Policy Analysis; IMF, etc. Chart 2 Business Conditions DI (Tankan) By Firm Size By Region DI ("favorable" - "unfavorable"), % points DI ("favorable" - "unfavorable"), % points "Favorable" "Favorable" "Unfavorable" -10 -10 -20 -20 -30 Large enterprises -40 Medium-sized enterprises -50 "Unfavorable" -30 Range of responses by region -40 Japan (all industries and enterprises) -50 Small enterprises -60 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 -60 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Source: Bank of Japan. Chart 3 Duration of Economic Recovery Period Rank Period Duration February 2002-February 2008 73 months December 2012(Current) 60 months November 1965-July 1970 (Izanagi boom) 57 months December 1986-February 1991 (Heisei boom) 51 months November 1993-May 1997 43 months Note: Economic peaks and troughs are judged based on discussions by experts after waiting for data accumulation. The current recovery phase, which started in December 2012, seems to have lasted for 60 consecutive months by November 2017. Sources: Cabinet Office, etc. Chart 4 Labor Market Conditions Active Job Openings-to-Applicants Ratio 2.0 s.a., ratio The mid-2000s Heisei boom Izanagi boom Current 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 CY 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Source: Ministry of Health, Labour and Welfare. Chart 5 Izanagi Boom Investment-GDP Ratio (Nominal) Wages and Prices y/y % chg. Jinmu boom Iwato boom Izanagi boom s.a., % Jinmu boom Iwato boom Izanagi boom Nominal wages CPI -5 CY 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 CY 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 Notes: 1. Shaded areas indicate economic expansion periods. 2. The CPI figures up to 1970 are the CPI for all items less imputed house rent and those from 1971 are that for all items less fresh food. 3. Figures for nominal wages are total cash earnings (establishments with 30 or more employees) based on quarterly data (up to 1960: annual data). Excluding "services" up to 1970. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Cabinet Office, etc. Chart 6 Heisei Boom Wages and Prices Investment-GDP Ratio (Nominal) y/y % chg. Heisei boom Nominal wages s.a., % Heisei boom CPI (all items less fresh food) -1 CY 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 CY 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 Notes: 1. Shaded areas indicate economic expansion periods. 2. The CPI figures are adjusted for changes in the consumption tax rate. 3. Figures for nominal wages are scheduled cash earnings (establishments with 30 or more employees). Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Cabinet Office, etc. Chart 7 Current Recovery Phase Software Investment (Tankan) Nominal Wages 3.5 y/y % chg. All industries Scheduled cash earnings (full-time employees) 3.0 FY 2005 = 100 Accommodations, eating & drinking services 2.5 Hourly scheduled cash earnings (part-time employees) Construction 2.0 Retailing 1.5 1.0 0.5 0.0 -0.5 -1.0 FY 05 Notes: 1. Nominal wages: Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. The figure for 2017/Q3 is the September-October average. 2. Figures for the software investment plans for fiscal 2017 are forecasts from the December 2017 Tankan survey. Sources: Ministry of Health, Labour and Welfare; Bank of Japan. Chart 8 Corporate Profits Ratio of Current Profits to Sales 6.5 % Izanagi boom 6.0 Heisei boom 5.5 The mid-2000s Current 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1 2 quarter 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 periods after entering economic recovery phases Note: Based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Figures show 4-quarter backward moving averages. Source: Ministry of Finance. Chart 9 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications.
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Oita, 31 January 2018.
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January 31, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Oita 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 Oita 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 Oita Branch. At the Monetary Policy Meeting (MPM) held last week, the Bank updated its projections for Japan's economic activity and prices through fiscal 2019 and released them in the January 2018 Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to talk 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 Report. I. The Current Situation of Economic Activity and Its Outlook Let me start by talking about economic developments. Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. The real GDP growth rate for the July-September quarter of 2017 was 2.5 percent on an annualized basis, representing positive growth for seven consecutive quarters (Chart 1). The benefits of the economic improvement have been spreading to a wide range of economic entities, and according to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan) released in December 2017, the diffusion indexes (DIs) for business conditions have continued to be positive, not only for large enterprises and manufacturers but also for small enterprises and nonmanufacturers. By region, in the Bank's January 2018 Regional Economic Report, all nine regions across the country, including the Kyushu region, showed positive economic assessments, using phrases such as moderate recovery and expansion. In what follows, I would like to talk about the current situation of Japan's economic activity and its outlook in more detail. Overseas Economies I would first like to touch upon developments in overseas economies. Looking back, overseas economies remained subdued following the global financial crisis in 2008. However, since around the second half of 2016, the positive effects of economic recovery in advanced economies have started to spread to emerging economies, and so-called synchronous growth has been achieved recently, with advanced and emerging economies growing in tandem. In this situation, production and trade activity of the manufacturing sector have become active due to the completion of inventory adjustments and an increase in business fixed investment on a global basis. World trade volume last year registered high growth that reflected such developments, growing at a faster pace than the global economy for the first time in six years. The global economy is expected to continue growing firmly for the time being. According to the January 2018 World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF), the global GDP growth rates for both 2018 and 2019 are expected to register relatively high growth of 3.9 percent, exceeding the long-term average since the 1990s (Chart 2). Current Situation of Japan's Economic Activity As I noted at the beginning, Japan's economy is expanding moderately, supported in part by such growth in overseas economies. With regard to the corporate sector, exports have shown high growth mainly for capital goods and IT-related goods. In particular, exports to China as well as the NIEs and the ASEAN economies have been rapidly increasing recently, and real exports for November 2017 reached record high levels, exceeding those seen before the global financial crisis. Production has also been on an uptrend on the back of a rise in demand both at home and abroad. Under these circumstances, the ratio of firms' current profits to sales has been at a record high level, and the DIs for business conditions for all industries and enterprises in the December 2017 Tankan suggest that business conditions have improved for six consecutive quarters, being at a favorable level seen for the first time in 26 years, since 1991. Business fixed investment has continued on an increasing trend in a wide range of industries, with corporate profits and business sentiment improving (Chart 3). Specifically, firms in the nonmanufacturing sector in industries such as restaurants, retailing, and construction have been significantly increasing their labor-saving and efficiency-improving investment (Chart 4). For instance, the introduction of online reservation systems and self-checkout machines across the country is no longer a new phenomenon. While the direct cause of such investment is acute labor shortage, it is also attributable to new technologies such as robots and artificial intelligence (AI) having become available for actual business activities as a result of technological innovation in recent years. For example, there have been various ideas recently related to making use of the latest technologies, such as using robots for heavy labor at nursing care facilities and drones for delivery services. Such positive corporate activities also have been firmly supported by financial institutions' accommodative lending attitudes. Turning to the household sector, as I mentioned earlier, labor market conditions have continued to tighten steadily amid economic expansion (Chart 5). The active job openings-to-applicants ratio for December 2017 improved to 1.59, a level seen for the first time in about 44 years, since 1974, and the unemployment rate has declined to a level seen for the first time in about 24 years. In this situation, wages have been rising moderately. Specifically, the year-on-year rate of increase in hourly wages of part-time employees, which are sensitive to economic activity, has marked relatively high growth of around 2 percent recently. Although the pace of wage increases for full-time employees has remained sluggish compared to that for part-time employees, the situation is gradually changing. Base pay rises returned in 2014, and moves to raise the starting salaries of full-time employees have been observed at many firms recently, aiming to secure the number of employees needed. Against the background of such improvement in the employment and income situation, private consumption has been increasing moderately, albeit with fluctuations (Chart 6). In detail, durable goods such as automobiles and household electrical appliances have been on a moderate increasing trend, due mainly to replacement demand, and nondurable goods such as clothes and food have been picking up recently. The favorable employment situation, together with the rise in stock prices, has led to an improvement in consumer sentiment, which also underpins consumption activities. Outlook for Japan's Economic Activity Next, I would like to turn to the Bank's outlook for Japan's economic activity. Japan's economy is likely to continue its moderate expansion. Exports are expected to continue their moderate increasing trend on the back of the growth in overseas economies, and business fixed investment and private consumption are likely to follow an increasing trend on the back of highly accommodative financial conditions and underpinnings through the government's past stimulus measures. According to the January 2018 Outlook Report, the medians of the Policy Board members' forecasts of the real GDP growth rates for fiscal 2017 and 2018 are 1.9 percent and 1.4 percent, respectively (Chart 7). These figures are above Japan's potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. In fiscal 2019, business fixed investment is likely to decelerate, mainly reflecting Olympic Games-related demand peaking out, and household spending is likely to turn to a decline in the second half of the fiscal year due to the effects of the scheduled consumption tax hike. Although the growth pace is projected to decelerate, the economy is expected to continue expanding, with the projected real GDP growth rate at 0.7 percent for fiscal 2019, as an increase in exports on the back of the growth in overseas economies underpins the economy. There are, of course, upside and downside risks to this baseline scenario of the outlook for Japan's economic activity. The biggest risk factor is developments in overseas economies. Uncertainty surrounding overseas economies seems to have abated compared to a while ago, as seen in economic recovery in emerging economies clearly taking hold and progress being made regarding the debt problem for the financial sector in Europe. However, the U.S. economic policies and negotiations on the United Kingdom's exit from the European Union (EU) continue to warrant attention. The Bank will continue to closely examine developments in overseas economies, including geopolitical risks. II. Price Developments and Their Outlook Price Developments Now, I will move on to price developments. The year-on-year rate of change in the consumer price index (CPI) in Japan has been increasing gradually since around mid-2016, mainly on the back of a rise in energy prices (Chart 8). The rate of change in the CPI excluding fresh food registered 0.9 percent in November and December last year, which is the level last seen in October 2014. With actual inflation rising, people's inflation expectations shifted from the weakening phase and have been more or less unchanged recently. However, excluding the effects of energy prices, the rate of change in the CPI has remained slightly positive, continuing to show relatively weak developments. While this reflects temporary factors such as a reduction in charges for mobile phone services, this is mainly attributable to the fact that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households. As evidence of such mindset and behavior, firms have been limiting wage increases -- which correspond to the labor shortage -- mainly to part-time employees, and it is taking time for such increases to spread to full-time employees. In addition, a wide range of firms have been making efforts to absorb a rise in labor costs by increasing labor-saving investment and streamlining their business processes through such measures as discontinuing late-night services. Outlook for Prices As these developments show, prices are relatively weak. Going forward, however, they are expected to overcome this situation, and the year-on-year rate of change in the CPI is likely to increase toward the price stability target of 2 percent. This is expected to be realized through the following mechanism. First, prices of items such as processed food and daily necessities -- which are responsive to economic activity -- are likely to rise gradually, and the yen's depreciation to date is expected to push up prices of such items as durable goods. Second, as the output gap improves further, firms' stance is likely to gradually shift toward raising wages and prices, and the inflation rate is projected to rise in line with wage increases. Third, with these factors pushing up actual inflation, a virtuous cycle is expected to operate in which people's inflation expectations rise accordingly, leading to a further increase in actual inflation. Bearing this mechanism in mind, the January 2018 Outlook Report shows that the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI excluding fresh food are 0.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and on a basis excluding the effects of the consumption tax hike, 1.8 percent for fiscal 2019 (Chart 7). The key to realizing the inflation mechanism that I just outlined is firms' wage- and price-setting stance. With regard to the price-setting stance, there has been a gradually increasing number of cases recently where firms reflect in their sales prices the increased labor costs and input costs. Media reports on price rises seem to have increased substantially of late. As mentioned in the Bank's Regional Economic Report, many firms reported that they have been reaching the limit to which they can undertake labor-saving investment in order to absorb increasing labor costs. Regarding the wage-setting stance, in a situation where labor shortage is not showing signs of being relaxed, but rather is becoming even more acute, an increasing number of firms seem to be considering raising wages of not only part-time but also full-time employees. While such an increase in labor costs contributes to pushing up sales prices, if many firms increase wages, households' income situation will improve and more consumers consequently will come to accept price rises. If that happens, price rises will not result in losing customers, likely leading to an increase in sales. As this shows, wage increases by firms also benefit themselves. In relation to wage increases, some argue that firms should allocate more of their cash on hand to their employees (Chart 9). While it is true that corporate savings have accumulated to a substantial degree lately, there are various backgrounds to this. For example, with memories of the severe funding conditions during the global financial crisis still fresh, some firms say that, for the time being, they prefer to accumulate earned cash on hand to be prepared for any future crisis. Others point to the fact that, even if they invest in capital and human resources, they cannot gain enough profits as Japan's expected growth rate is low. However, in a situation where Japan's economy has been improving steadily and is likely to continue expanding going forward, these do not seem to be the main reasons for the increase in corporate savings. Rather, it appears that the recent rapid increase in corporate profits was an unexpected windfall for firms. If that is the case, the savings are likely to be used for business fixed investment and wage increases with some time lag. While an increase in fixed investment is preceding so far, the increased savings are likely to lead to wage growth going forward, as real wages have not been rising in line with labor productivity. III. The Bank's Conduct of Monetary Policy Next, I will talk about the Bank's conduct of monetary policy. The Bank has been conducting monetary policy under "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" since September 2016. This framework consists of two components (Chart 10). The first is an inflation-overshooting commitment. This is the Bank's strong commitment that it will continue expanding the monetary base until the year-on-year rate of increase in the actual CPI exceeds 2 percent and stays above that level in a stable manner. It is crucial that people actually experience inflation above 2 percent 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, under the inflation-overshooting commitment, has committed itself to continuing with large-scale monetary easing until such situation is achieved. The second component is yield curve control. The Bank facilitates the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent, taking account of developments in Japan's economic activity and prices as well as financial conditions. At present, it 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 zero percent, conducting JGB purchases so as to achieve this target level. As I mentioned earlier, Japan's economy is expanding moderately but prices are relatively weak. Thus, there is still a long way to go to achieve the price stability target of 2 percent. In light of such recent developments in economic activity and prices as well as financial conditions, the Bank deems it important to continue to persistently pursue powerful monetary easing under the framework of "QQE with Yield Curve Control." While the Bank believes it important to continue with the current monetary easing persistently, some argue that continuing with monetary easing for a long period entails risks. In what follows, I would like to express my views on the two risks that have been pointed out. The first risk of continuing with the current monetary easing policy is that the efficiency of Japan's economy would be hampered, due to the continuation of firms' inefficient resource allocation and to firms with low productivity remaining in place amid funding costs staying at significantly low levels. However, I instead think that it would be difficult to heighten the efficiency and dynamism of the economy and thereby raise productivity unless the economy is underpinned by an appropriate conduct of monetary easing. This is because, under deflation, strong resistance will arise against the pain -- such as an increase in unemployment -- that emerges in the course of raising productivity through firms' efforts. In Japan's economy today, monetary policy has exerted its intended effects, and supply-side constraints such as shortages of labor and capital have become evident amid an improvement in the output gap. Given this situation, now is the best opportunity for firms to promote investment in human resources and capital for the purpose of raising labor productivity. In the process of raising labor productivity, there usually is a concern of an increase in unemployment, which is one of the reasons why firms are reluctant to undertake fixed investment, including in software. Nevertheless, in the situation of the current labor shortage, there are good chances to change jobs -- enough to absorb the possible increase in unemployment. In this context, the Bank's current monetary policy can be considered as contributing to providing the conditions for raising labor productivity. In fact, as I mentioned earlier, a pronounced increase has been observed in investment aimed at saving labor and streamlining business processes in industries where labor shortage is acute. Speaking of raising labor productivity, firms will be more strongly motivated to do so through creating a competitive environment by abolishing competition-restricting regulations, including those on market entry and on prices, than through support policies such as the provision of subsidies for firms. If the government promotes its initiatives toward enhancing competition, such as abolishment of the so-called bedrock regulations, many firms are expected to enter the market. In such situation, if more firms take advantage of accommodative financial conditions, capital investment will be reinforced and technological innovation will progress, leading the potential growth rate to rise and monetary easing effects to become larger. As a result, the price stability target of 2 percent can be achieved earlier than projected. Therefore, I expect that the government's regulatory and institutional reforms will be pushed forward strongly. The second risk pointed out is that, if the current monetary easing measures will continue to be taken, fiscal discipline will loosen and fiscal sustainability will be lost because the government can issue debt at low interest rates under such circumstances. While fiscal management is conducted under the responsibility of the government and the Diet, it is important to secure the market's confidence in medium- to long-term fiscal soundness. In the joint statement by the government and the Bank of Japan in January 2013, it says that the government "will steadily promote measures aimed at establishing a sustainable fiscal structure." That being said, a combination of accommodative financial conditions provided by the central bank and fiscal spending proactively carried out by the government is called a "policy mix," and it is well known as a standard macroeconomic policy that synergy effects from both sides can produce stronger economic stimulus effects. In Japan, under the Bank's QQE, the government is to conduct flexible fiscal policy as the second arrow of Abenomics. In my understanding, what is meant by flexible fiscal policy is that the government will formulate a supplementary budget beforehand when an economic downturn is expected, and thereby increase fiscal spending or implement tax reductions. Then, the issue would be how to reconcile medium- to long-term fiscal soundness and flexible fiscal policy. In what follows, I would like to present my view on this. Please take a look at the left-hand panel of Chart 11. This shows the year-on-year rates of change in the fiscal balance-to-GDP ratio and the primary balance-to-GDP ratio. The higher the blue and white column graphs go above zero, the larger the reduction in the fiscal deficit-to-GDP ratio and the primary deficit-to-GDP ratio, or in other words, the faster the pace of fiscal austerity. From fiscal 2010 to fiscal 2012, the pace of fiscal austerity was relatively moderate, and the degree of monetary accommodation was not enough. On the other hand, from fiscal 2013 -- when QQE was introduced -- to fiscal 2015, the pace of fiscal austerity accelerated. In particular, it surged in fiscal 2014 because the consumption tax was raised from 5 percent to 8 percent. Even though the government formulated in that fiscal year economic measures of 5 trillion yen as part of flexible fiscal policy, the real GDP growth rate declined to minus 0.3 percent. The pace of fiscal austerity started to slow in fiscal 2015 and decelerated significantly in fiscal 2016. On the back of that decline, coupled with powerful monetary easing, the real GDP growth rate has been increasing since fiscal 2015, outpacing the potential growth rate -- which is estimated to be in the range of 0.5-1.0 percent -- by around 0.5 percentage point. Please take a look at the right-hand panel of Chart 11. In this panel, the degree of fiscal soundness is shown by developments in the ratio of the amount outstanding of gross government debt to nominal GDP, and we can see that the ratio marked the highest figure in 2014 despite the consumption tax hike in April that year. In order to properly gauge the fiscal conditions, the ratio of the amount outstanding of net government debt -- calculated by subtracting the amount outstanding of the government's holdings of financial assets from that of gross government debt -- to nominal GDP also should be taken into consideration. As with the case of the ratio of the amount outstanding of gross government debt to nominal GDP, this ratio also rose in 2014, when the consumption tax hike took place. However, given that it has been more or less flat since 2012, one cannot necessarily say that Japan's fiscal conditions are becoming worse. In considering the combination of fiscal soundness and monetary easing measures, it would be effective to look at the experience of the euro area. Please take a look at Chart 12. This shows the pace of fiscal austerity and economic growth in the euro area. The pace of fiscal austerity is shown by the annual changes in the following ratios: the fiscal balance-to-GDP ratio; the primary balance-to-GDP ratio; and the ratio of structural balance -- calculated by excluding the effects of economic fluctuations from the actual fiscal balance -- to GDP. As in Chart 11, the higher the column graphs go above zero, the faster the pace of fiscal austerity. In the euro area, the economy was under strong downward pressure from 2010 to 2012, not only because the degree of monetary accommodation was not enough but also because the pace of fiscal austerity was accelerating. Consequently, the economy experienced negative growth in 2012 and 2013, and the ratios of the amounts outstanding of both gross and net government debt to nominal GDP rose, even though the governments continued with fiscal austerity. Through such experience, in 2013, the governments in the euro area started to shift their policy to where the pace of fiscal austerity was slowed. Against this background, monetary policy to increase the degree of monetary accommodation also was introduced successively, and quantitative easing (QE) was introduced in 2015. At one point, a concern arose that the euro area might fall into deflation, just as in the case of Japan. However, the combination of such fiscal and monetary policy worked well and, since 2014, the euro area economy has recovered and its growth rate has been on an uptrend. The ratios of the amounts outstanding of both gross and net government debt to nominal GDP have continued to decline, albeit moderately, even though the governments slowed the pace of fiscal austerity. Although it is important to achieve fiscal soundness in the medium to long run, the pace of achievement -- or in other words, the pace of fiscal austerity -- affects the real economy largely. If the government rushes to achieve fiscal soundness and accelerates the pace of fiscal austerity, the growth rate will decline. If this happens, fiscal soundness will not be achieved, and achievement of the price stability target of 2 percent also will become difficult. It has been nearly five years since the introduction of QQE in April 2013. In concluding my speech, let me express my view on economic and price developments, as well as policy effects over the past five years. First, during the five years since the introduction of QQE, Japan's economic and price developments have improved significantly, and the economy is no longer in deflation, which is generally defined as a sustained decline in prices. Through the implementation of large-scale monetary easing under the strong and clear commitment toward achieving the price stability target of 2 percent, people's basic view on monetary policy has changed drastically, bringing about a rise in inflation expectations and a decline in nominal interest rates across the entire yield curve. Triggered by the decline in real interest rates, excessive yen appreciation has been corrected and stock prices have risen significantly. On the real economy side, the output gap has improved and the employment situation has done so to a substantial degree. Second, despite these improvements, we are only halfway to achieving the price stability target of 2 percent. I think the main reason for this is as follows: the observed inflation rates started to decline before inflation expectations anchored at 2 percent, due mainly to the consumption tax hike and the significant decline in crude oil prices, and this led inflation expectations, of which formation has been largely adaptive, to become relatively weak. In this situation, in order to achieve the price stability target of 2 percent, it is necessary to raise the observed inflation rates through an improvement in the output gap, which will be brought about by continuing with monetary easing persistently, and thereby lift inflation expectations. "QQE with Yield Curve Control" that the Bank currently adopts incorporates the mechanism in which the price stability target of 2 percent can be achieved through raising inflation expectations -- although it may take some time -- by maintaining nominal interest rates at low levels. This is the most appropriate monetary policy framework at present, in that it has the largest positive effects and the smallest side effects. The Bank must keep seeking whether there is more appropriate monetary policy, but unless the effectiveness of a new policy is assured, I think it should continue with the current monetary policy. Third, in addition to an appropriate monetary easing policy, the government's initiatives are important in order to achieve sustainable economic growth under price stability. With a view to achieving further growth in Japan's economy, I strongly expect that the government will set an appropriate pace for fiscal austerity, as I described earlier, and that it will carry out growth strategy -- such as competition policy -- appropriately and powerfully. In addition, under the current economic situation where the increase in income is sluggish and consumption has not gained enough momentum, an income shift -- through an income reallocation policy -- to households with a high propensity to consume is also effective. On this point, the government set out measures to support child rearing and education including the provision of early childcare as well as higher education for free, as part of the "human resources development revolution" in the New Economic Policy Package. This is an effective macroeconomic policy that can expand domestic demand led by consumption, through properly combining the tax system and fiscal spending and making sure the pace of fiscal austerity is appropriate. With these initiatives becoming effective, I hope that Japan's economy will achieve higher growth in real terms in the near future under the stable inflation rate of around 2 percent. Conclusion Since 2016, several natural disasters -- the Kumamoto Earthquake, the torrential rain in Northern Kyushu, and the 18th typhoon in 2017 -- hit Oita Prefecture and caused damage to its tourism and agriculture. I would like to offer my heartfelt sympathies to those who suffered, and I deeply respect the efforts by people in the region who faced difficulties. In Oita Prefecture, big events are scheduled to take place this year, such as the International ONSEN Summit and the "National Cultural Festival and the National Disabled Craft and Culture Festival." In addition, the Rugby World Cup is to be held next year. I would like to close my speech by expressing my sincere hope that, through these opportunities, the public and private sectors will work together on vitalizing the local economy in various fields, and that the local economy will be strongly revived after the massive disasters. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Oita January 31, 2018 Kikuo Iwata Deputy Governor of the Bank of Japan Chart 1 Real GDP s.a., ann., tril. yen CY 06 Source: Cabinet Office. Chart 2 Global Economy Global Real GDP Growth y/y % chg. World output y/y % chg. CY 2018: +3.9% 2019: +3.9% Projections of Real GDP Growth by Major Economies (as of January 2018) IMF projection 3.2 3.7 Advanced economies 1.7 2.3 United States 1.5 2.3 Euro area 1.8 2.4 Japan 0.9 1.8 4.4 4.7 China 6.7 6.8 ASEAN 5 4.9 5.3 World CY 1990-2017 average: +3.6% -1 CY 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Emerging market and developing economies Note: The figure for 2017 is estimated value. Figures in parentheses in the right figure show differences from the projections as of October 2017 (% points). Source: IMF. [Projection] [Projection] 3.9 (+0.2) 2.3 (+0.3) 2.7 (+0.4) 2.2 (+0.3) 1.2 (+0.5) 4.9 (0.0) 6.6 (+0.1) 5.3 (+0.1) 3.9 (+0.2) 2.2 (+0.4) 2.5 (+0.6) 2.0 (+0.3) 0.9 (+0.1) 5.0 (0.0) 6.4 (+0.1) 5.3 (0.0) Chart 3 Japan's Economy Business Conditions DI (Tankan) s.a., % Ratio of current profits to sales (all industries and enterprises) Business Fixed Investment DI ("favorable" - "unfavorable"), % points 千 Corporate Profits "Favorable" "Unfavorable" s.a., ann., tril. yen Private nonresidential investment (SNA, real) -10 -20 -30 -40 CY05 06 07 08 09 10 11 12 13 14 15 16 17 -50 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 All industries and enterprises CY05 06 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Sources: Ministry of Finance; Bank of Japan; Cabinet Office. Chart 4 Labor Market Conditions and Software Investment Software Investment (Tankan) Employment Conditions DI (Tankan) -80 -60 reversed, DI ("excessive" - "insufficient"), % points All industries Construction Retailing Accommodations, eating & drinking services FY 2005 = 100 All industries Construction Retailing Accommodations, eating & drinking services -40 "Insufficient" -20 "Excessive" CY05 06 07 08 09 10 11 12 13 14 15 16 17 FY 05 Note: Figures for the software investment plans for fiscal 2017 are forecasts from the December 2017 Tankan survey. Source: Bank of Japan. Chart 5 Employment Situation Unemployment Rate Active Job Openings-to-Applicants Ratio 1.8 s.a., ratio s.a., % 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 CY85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. CY 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Chart 6 Private Consumption Confidence Indicator Related to Private Consumption Consumption Activity Index s.a., CY 2010＝100 s.a. Improved Consumption Activity Index (travel balance adjusted, real) CY05 06 07 08 09 10 11 12 13 14 15 16 17 Worsened Economy Watchers Survey (household activity) CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. The Consumption Activity Index is based on BOJ staff calculations. Figures for the Consumption Activity Index (travel balance adjusted) exclude inbound tourism consumption and include outbound tourism consumption. The figure for 2017/Q4 is the October-November average. 2. Figures for the "Economy Watchers Survey" are those for the current economic conditions DI. Sources: Bank of Japan; Cabinet Office. Chart 7 Outlook for Economic Activity and Prices (as of January 2018) y/y % chg. Real GDP Fiscal 2017 Forecasts made in October 2017 Fiscal 2018 Forecasts made in October 2017 Fiscal 2019 Forecasts made in October 2017 CPI (all items less fresh food) +1.9 +0.8 +1.9 +0.8 +1.4 +1.4 +1.4 +1.4 +0.7 +1.8 +0.7 +1.8 Note: Figures indicate the medians of the Policy Board members' forecasts (point estimates). Figures for the CPI (all items less fresh food) exclude the effects of the consumption tax hike. Source: Bank of Japan. Chart 8 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 9 Corporate Savings Amount Outstanding of Cash and Deposits by Firm Size amount outstanding, tril. yen ratio to total assets, % Large enterprises (left scale) Small and medium-sized enterprises (left scale) Ratio to total assets (large, right scale) Ratio to total assets (small and medium, right scale) FY-end 85 Note: Based on the Financial Statements Statistics of Corporations by Industry, Annually. Excluding "finance and insurance." Large enterprises are defined as enterprises with a capitalization of 1 billion yen or more, and small and medium-sized enterprises are defined as enterprises with a capitalization of less than 1 billion yen. Source: Ministry of Finance. Chart 10 QQE with Yield Curve Control Yield Curve Control Inflation-Overshooting Commitment Inflation rate 1.2 % 1.0 0.8 2% 0.6 0.4 JGB yield curve Short-term policy interest rate "minus 0.1 percent" Target level of the long-term interest rate "around zero percent" 0.2 0.0 -0.2 -0.4 Expansion of monetary base continues Source: Bloomberg. 0 1 2 3 4 5 6 7 8 9 10 15 20 year Residual maturity Chart 11 Fiscal Conditions in Japan Amount Outstanding of Government Debt Fiscal Balance and Primary Balance ratio to nominal GDP, % points y/y % chg. Acceleration in the pace of fiscal austerity (decline in fiscal deficit) ratio to nominal GDP, % ratio to nominal GDP, % -1 -1 -2 -2 -3 -3 Gross government debt (left scale) Fiscal balance (y/y chg., left scale) -4 Primary balance (y/y chg., left scale) -5 -6 FY 08 -4 -6 Note: The primary balance is BOJ staff calculations. Sources: Cabinet Office; IMF, etc. Net government debt (right scale) -5 Real GDP (right scale) CY 08 Chart 12 Fiscal Conditions in the Euro Area Amount Outstanding of Government Debt Fiscal Balance, Primary Balance, and Structural Balance y/y % chg. ratio to nominal GDP, % points Acceleration in the pace of fiscal austerity (decline in fiscal deficit) -1 -1 -2 -2 -3 Fiscal balance (y/y chg., left scale) -3 -4 Primary balance (y/y chg., left scale) -4 -5 Gross government debt (left scale) CY 08 Note: The structural balance is the year-on-year rate of change in the structural balance-to-potential GDP ratio. Source: IMF. Net government debt (right scale) -5 -6 Real GDP (right scale) -6 CY 08 ratio to nominal GDP, % ratio to nominal GDP, % Structural balance (y/y chg., left scale)
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bank of japan
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Speech by Mr Hitoshi Suzuki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Wakayama, 8 February 2018.
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February 8, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Wakayama Hitoshi Suzuki Member of the Policy Board (English translation based on the Japanese original) I. Recent Economic and Price Developments A. Overseas Economies I would like to begin my speech by talking about overseas economies. Overseas economies have continued to grow at a moderate pace on the whole in a situation where an improving trend in the business sentiment of manufacturing firms has been strengthening further on a global basis. The U.S. economy has continued to recover firmly, mainly in household spending, owing to a steady improvement in the employment and income situation. Private consumption and housing investment have been on a moderate increasing trend, partly supported by this favorable employment and income situation. In terms of the outlook, the U.S. economy is expected to continue to see firm growth driven by domestic private demand. The European economy as a whole also has continued to recover steadily in a situation where private consumption has been on an increasing trend, partly supported by improvements in the labor market and consumer sentiment, and firms' production activity has been solid. As for the outlook, the European economy is expected to continue its moderate recovery, while uncertainty -- for example, over political issues such as those regarding negotiations on the United Kingdom's exit from the European Union (EU) -- is likely to weigh on its activity. The Chinese economy has continued to see stable growth on the whole, partly due to the effects of authorities' measures to support economic activity, amid an uptrend in exports. As for the outlook, the economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Emerging economies other than China and commodity-exporting economies as a whole have been recovering moderately, due mainly to the increase in exports and the effects of the economic stimulus measures of these economies. Their growth rates 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. According to the January 2018 World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF), global growth is projected to be 3.9 percent in 2018, exceeding the estimate for 2017 of 3.7 percent (Chart 1). Together with high stock prices worldwide, the economy could deviate upward from the baseline scenario depending on the developments in fiscal and monetary policies and structural reforms in each country. However, due attention should be paid to factors that could exert downside risks to economic activity, such as (1) the U.S. economic policies and their impact on global financial markets, (2) developments in emerging and commodity-exporting economies, negotiations on the United Kingdom's exit from the EU and their effects, and geopolitical risks. I consider it important to also focus on the following: the fact that spreads for U.S. high-yield bonds have narrowed in the U.S. economy to a level close to that seen right before the global financial crisis in 2008; the fact that stock prices, which had been on an uptrend, fell sharply in early February by more than the decline seen in a day at times during the global financial crisis in 2008; and how U.S. long-term interest rates and capital flows to emerging and commodity-exporting economies are affected by moves toward normalization of monetary policy in the United States and Europe. Moreover, developments in commodity prices -- including crude oil prices, which have continued to increase -- also could be risks to the outlook (Chart 2). This is because excessive rises in commodity prices could lead to a rise in firms' expenses for materials, while sudden drops may bring about market turmoil. B. Current Situation and Outlook of Japan's Economy I will now discuss the economic situation in Japan. Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. Reflecting developments in firms' exports and business fixed investment, the real GDP growth rate for the July-September quarter of 2017 was 2.5 percent on an annualized quarter-on-quarter basis, representing positive growth for seven consecutive quarters (Chart 3). This is a level above Japan's potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. As the background to these developments, we can point to the fact that real exports have been on an increasing trend on the back of the growth in overseas economies and business fixed investment has continued on an increasing trend with corporate profits and business sentiment improving (Charts 4 and 5). Owing to steady improvement in the employment and income situation, private consumption also has been increasing moderately, albeit with fluctuations. According to the Regional Economic Report released by the Bank of Japan in January 2018, out of a total of nine regions across Japan, six regions, including the Kinki region, reported that their economy had been expanding or expanding moderately. In particular, the Kinki region -- of which Wakayama Prefecture is part -- revised up its assessment based on the strengthened momentum in exports and the improvement in private consumption, marking three consecutive quarters of upward revisions since July 2017 (Chart 6). With Japan's economic expansion, supply-demand conditions in the labor market have tightened steadily. Firms' perception of labor shortage suggested by the diffusion indexes (DIs) for the employment conditions in the December 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) has heightened in a wide range of industries, and the unemployment rate has been in the range of 2.5-3.0 percent. The active job openings-to-applicants ratio is at its highest level since 1974, and the ratio for full-time workers has recorded a historical high (Chart 7). Against this backdrop, labor-saving investment has increased in a wide range of industries with a view toward using artificial intelligence (AI), robotic process automation (RPA), and other means. Some are concerned that, if the use of AI and RPA increases, labor positions would be taken over by robots and machines, thereby easing labor market conditions. Viewed from a long-term perspective, however, given that Japan's population is expected to decline, the labor force, which has continued to increase, may peak out. Moreover, since firms are likely to be in need of new employees to provide new products and services brought about through innovation and to make up for a reduction in work hours under working-style reforms, there is a good chance that labor market conditions could tighten. With regard to the outlook, Japan's economy is likely to continue its moderate expansion. Through fiscal 2018, 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 underpinnings through the government's past stimulus measures. Business fixed investment is likely to continue increasing, supported by firms' heightened growth expectations and increases in Olympic Games-related investment, as well as in labor-saving investment to address labor shortages. Private consumption is also expected to follow a moderate increasing trend as the employment and income situation continues to improve. Moreover, exports are expected to continue their moderate increasing trend on the back of the growth in overseas economies. In fiscal 2019, although business fixed investment is likely to decelerate -- mainly reflecting cyclical adjustments in capital stock as well as Olympic Games-related demand peaking out -- and household spending is likely to decline in the second half of the fiscal year due to the effects of the scheduled consumption tax hike, Japan's economy is expected to continue expanding, supported in part by the increase in exports led by external demand. According to the Bank's January 2018 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the medians of the Policy Board members' forecasts of the real GDP growth rate are 1.9 percent for fiscal 2017, 1.4 percent for fiscal 2018, and 0.7 percent for fiscal 2019 (Chart 8). C. Current Situation and Outlook of Prices Turning to price developments, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is currently 0.9 percent. The rate has been on an improving trend, although gradual, since January 2017, when it started to increase. During the 12 months since then, the rate rose by more than 1 percentage point (Chart 9). I believe that there are three factors to consider when projecting the outlook for prices. The first is the output gap, which determines future inflation rates. The output gap has widened steadily within positive territory on the back of the steady tightening of labor market conditions and a rise in capital utilization rates (Chart 10). In this situation, firms' moves to raise their employees' wages and prices have started to be seen. Furthermore, upward pressure on prices is heightening steadily. Specifically, labor market conditions have been tightening further in a wide range of industries -- as evidenced by the medical and nursing service industry, for example, where labor shortage has become more severe amid an increase in job openings resulting from large firms entering the market -- and hourly cash earnings of part-time employees in particular have started to increase. Against this backdrop, in the service industry, such as dining-out and transportation, some firms have started to raise prices since the second half of 2017 by passing a rise in labor costs -- arising from labor shortage -- on to prices. The second factor is medium- to long-term inflation expectations, which are more or less unchanged, after having remained in a weakening phase since summer 2015 (Chart 11). Going forward, with the improvement in the output gap, firms' stance is likely to gradually shift toward raising wages and prices and is expected to push up the observed inflation rate, as I mentioned earlier. In this way, inflation expectations are likely to rise through the adaptive component, in which expectations are formed in a backward-looking manner. In addition, medium- to long-term inflation expectations are likely to be raised in particular by the forward-looking component, which will be in place, as the Bank pursues monetary easing through its strong commitment to achieving the price stability target. The third factor is import prices. The effect of a pick-up in crude oil prices since spring 2016 is likely to wane moderately, while the yen's depreciation since autumn 2016 is likely to increase upward pressure on prices for the time being. In this regard, I think it will take some time to achieve the price stability target, although this seems to be on track so far; favorable conditions for prices to rise at a faster pace going forward are beginning to materialize. Therefore, the year-on-year rate of increase in the CPI (all items less fresh food) is projected to continue on an uptrend and will likely reach around 2 percent around fiscal 2019. 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 2018 Outlook Report are 0.8 percent for fiscal 2017, 1.4 percent for fiscal 2018, and, excluding the direct effects of the scheduled consumption tax hike, 1.8 percent for fiscal 2019 (Chart 8). Nevertheless, what warrants attention is developments in the CPI for all items less fresh food and energy, which is essential to the year-on-year rate of increase in the CPI for all items less fresh food rising further toward the price stability target going forward. With that being said, since there may be some time lag until the effects of labor shortages and the hike in expenses for materials will be reflected in prices of goods and services provided by firms more widely across industries, I will continue to pay close attention to firms' actions toward raising prices of goods and services. II. Conduct of Monetary Policy A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control Let me now turn to the Bank's monetary policy. In April 2013, the Bank introduced QQE to overcome deflation that had lasted for nearly 15 years. In September 2016, from the viewpoint of further strengthening the effects of monetary easing, it introduced a new policy framework of QQE with Yield Curve Control -- consisting of yield curve control, in which the Bank controls short- and long-term interest rates, and an inflation-overshooting commitment. The new policy framework has two key features. The first is to facilitate the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent. With yield curve control, the Bank seeks a decline in real interest rates by controlling short- and long-term interest rates in a situation where QQE has brought about positive effects on economic activity and prices mainly through the decline in real interest rates. In theory, the new framework aims to lower the observed real interest rates -- which are obtained by subtracting inflation expectations from the nominal interest rates -- to levels below the natural rate of interest, which is the real interest rate at which the economy neither accelerates nor decelerates. The basic mechanism is that, when the observed real interest rates are lower than the natural rate of interest, this stimulates economic activity, leading to acceleration of economic growth; as the output gap improves, upward pressure on prices is generated. Second, as another means of lowering the observed real interest rates, the inflation-overshooting commitment, under which the Bank works on people's expectations to increase inflation expectations, is also important. The Bank aims to push up inflation expectations and further strengthen the effects of monetary easing by making a strong commitment to 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. B. Effects of Monetary Easing Since the introduction of QQE with Yield Curve Control, the year-on-year rate of change in the CPI for all items less fresh food -- which had declined to minus 0.5 percent in September 2016 -- rose nearly 1.5 percentage points to 0.9 percent in November 2017. Short- and long-term interest rates also have thus far been maintained at levels consistent with the Bank's guideline for market operations. In addition, the sustainability of its policy framework has increased, in that the amount of the Bank's JGB purchases varies flexibly according to financial market conditions at the time. With regard to inflation expectations, the results of the 72nd Opinion Survey on the General Public's Views and Behavior (December 2017 Survey) released by the Bank in January 2018 suggests that monetary easing has started to influence people's inflation expectations; the proportions of respondents who answered that prices would go up one year from now and over the next five years increased compared to the previous survey conducted in September 2017 (Chart 12). Although the inflation rate has been rising since the introduction of QQE with Yield Curve Control, there is still some way to go to achieving the price stability target. Let me note, however, that Japan's economy has been expanding firmly. The conditions of a further rise in prices are also beginning to materialize, judging from (1) the rise in prices of goods traded among firms, reflecting increases in commodity prices such as crude oil prices, the tightening of labor market conditions, and (3) the government's various efforts toward improving firms' productivity and increasing wages. Thus, I consider that the momentum toward achieving the price stability target is maintained. Given this situation, I believe that it is important to persistently maintain powerful monetary easing under QQE with Yield Curve Control. C. Regarding Future Conduct of Monetary Policy Based on the objectives of monetary policy and its effects that I have outlined so far, let me now discuss two points regarding the future conduct of such policy that warrant attention. First, while a situation where prices do not rise easily persists, the following achievements are confirmed: the real GDP growth rate registered positive growth for seven consecutive quarters, and the Financial Statements Statistics of Corporations by Industry (FSSC) released by the Ministry of Finance showed that current profits reached a record high level and that internal reserves for nonfinancial corporations for fiscal 2016 reached a historical high exceeding 406 trillion yen (Chart 13). Nevertheless, the ratios of investments and personnel expenses to corporate profits have remained low, and I believe that increasing the proportion of firms' on-hand liquidity to be spent for future business fixed investment, research and development, and employees' wages will lead to a rise in wages and prices (Chart 14). The same could be said for individuals. Many people have saved money because of anxiety over issues such as a possible decline in the receipt of pension benefits and an increasing burden of medical expenses in the future. I also hear that, amid the recent stock price hike, gains on stock sales have accumulated as bank deposits. If these funds were used for private consumption, owing to an improvement in the employment and income situation, corporate profits would be pushed up further and an economic virtuous cycle would operate. To address this situation, on December 8, 2017, the Cabinet decided the New Economic Policy Package, which placed "Supply System Innovation" and "Human Resources Development" as major pillars. The government has laid out measures such as providing preferential tax treatment for firms that have raised wages. I consider that these measures by the government, coupled with the Bank's monetary easing, will play an important role in realizing an economy in which the virtuous cycle operates firmly. Second, as I mentioned earlier, short- and long-term interest rates have been maintained at levels consistent with the Bank's guideline for market operations for more than a year since the introduction of QQE with Yield Curve Control in September 2016. However, looking back at the aftermath of Black Monday in 1987 and the global financial crisis in 2008, during which I worked as a market practitioner, the market is volatile by nature, much like a living creature; therefore, close attention should continue to be paid to the effects of the current large-scale monetary easing on developments in economic activity and prices, as well as financial conditions. In particular, I focus on the effects imposed on (1) yields on securities held by financial institutions and their lending rates, (2) developments in corporate bond rates and flow of funds between firms and investors based on these rates, and (3) investments by insurance companies and pension funds. In a situation where firms find it easier to raise funds under a low interest rate environment, financial institutions have been taking an active lending stance, and the amount outstanding of bank loans has in fact been increasing (Chart 15). Meanwhile, financial institutions' earnings have been reduced, due in part to a further decline in lending rates brought about by intensifying competition among banks and to a decline in yields on securities held by financial institutions. At least for now, I believe that financial institutions in Japan as a whole have robust resilience against stress in terms of both capital and liquidity, and stability in the financial system has been maintained. However, it is necessary to carefully monitor how monetary policy will affect the financial system and the financial intermediation function, including the cumulative effects stemming from sustaining the Bank's large-scale monetary easing. Moreover, in facilitating the formation of an appropriate yield curve, the Bank should take account of economic, price, and financial conditions, as was indicated when QQE with Yield Curve Control was introduced in September 2016. Thank you very much for your attention. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Wakayama February 8, 2018 Hitoshi Suzuki Bank of Japan Chart 1 Global Economy IMF Projections (as of January 2018) Real GDP Growth Rate of the World Economy real GDP growth rate, y/y % chg. CY 3.2 3.7 Advanced economies 1.7 2.3 United States 1.5 2.3 Euro area 1.8 2.4 United Kingdom 1.9 1.7 Japan 0.9 1.8 4.4 4.7 6.4 6.5 China 6.7 6.8 ASEAN 4.9 5.3 Russia -0.2 1.8 Latin America and the Caribbean -0.7 1.3 Emerging and developing Asia estimates projection projection World Emerging market and developing economies 3.9 (0.2) 2.3 (0.3) 2.7 (0.4) 2.2 (0.3) 1.5 (0.0) 1.2 (0.5) 4.9 (0.0) 6.5 (0.0) 6.6 (0.1) 5.3 (0.1) 1.7 (0.1) 1.9 (0.0) 3.9 (0.2) 2.2 (0.4) 2.5 (0.6) 2.0 (0.3) 1.5 (-0.1) 0.9 (0.1) 5.0 (0.0) 6.6 (0.1) 6.4 (0.1) 5.3 (0.0) 1.5 (0.0) 2.6 (0.2) Source: International Monetary Fund. Note: Figures in parentheses are the difference from the October 2017 World Economic Outlook projections. y/y % chg. Avg. growth rate (1980-2017): +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 Source: International Monetary Fund. Note: As of January 2018. Figures are calculated using GDP based on purchasing power parity (PPP) shares of the world total from the International Monetary Fund. Chart 2 International Commodity Prices oil: $/bbl, copper: 100 $/t, monthly avg. ドバイ・原油 Crude oil (Dubai) 銅 Copper CY 01 Sources: Nikkei Inc.; Bloomberg. Chart 3 Japan's Economy: Real GDP s.a., ann., q/q % chg. s.a., tril. yen s.a., q/q % chg. Real GDP (nominal, right scale) 3Q Real GDP growth rate (left scale) Source: Cabinet Office. 4Q 1Q 2Q 3Q Real GDP 0.2 0.3 0.4 0.7 0.6 [ann., q/q] [0.9] [1.4] [1.5] [2.9] [2.5] Private Consumption 0.4 0.1 0.4 0.9 -0.5 Private Non-Resi. Investment -0.2 1.5 0.2 1.2 1.1 Private Residential Investment 3.0 0.2 0.9 1.3 -1.0 Public Demand 0.4 -0.7 0.2 1.1 -0.5 Exports of Goods & Services 2.1 3.0 1.9 -0.1 1.5 Source: Cabinet Office. Chart 4 Exports and Corporate Profits Real Exports and Real Imports Corporate Profits s.a., CY 2015=100 s.a., % Real exports Ratio of current profits to sales 売上高経常利益率 Ratio of operating profits to sales 売上高営業利益率 Real imports CY 01 CY Source: Bank of Japan. Chart 5 Investment-GDP Ratio (Nominal) s.a., % Average of investment-GDP ratio from 1994 CY 94 Source: Ministry of Finance. Note: Based on the "Financial Statements Statistics of Corporations by Industry, Quarterly." Excluding "finance and insurance." Business Fixed Investment Source: Cabinet Office. Regional Economic Assessments Chart 6 Comparison of Previous and Current Assessments by Region (Regional Economic Report) Changes from the previous assessment Region Assessment in October 2017 Assessment in January 2018 Hokkaido The economy has been recovering. The economy has been recovering. Tohoku The economy has continued its moderate recovery trend. The economy has continued to recover moderately. Hokuriku The economy has been expanding moderately. The economy has been expanding. KantoKoshinetsu The economy has been expanding moderately. The economy has been expanding moderately. Tokai The economy has been expanding. The economy has been expanding. Kinki The economy has been expanding moderately. The economy has been expanding moderately, with its growth becoming more solid. Chugoku The economy has been expanding moderately. The economy has been expanding moderately. Shikoku The economy has continued to recover moderately. The economy has continued to recover moderately. KyushuOkinawa The economy has been expanding moderately. The economy has been expanding moderately. Source: Bank of Japan. Chart 7 Labor Market Conditions Unemployment Rate and Active Job Openings-to-Applicants Ratio s.a., ratio s.a., % Diffusion Index of Employment Conditions (Tankan) reversed, DI ("Excessive employment" minus "Insufficient employment"), % points Insufficient employment Unemployment rate (right scale) Excessive employment Active job openings-to-applicants Ratio (left scale) Active job openings-to-applicants ratio for full-time employees (left scale) CY CYCY Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Source: Bank of Japan. Chart 8 "Outlook for Economic Activity and Prices" (January 2018) Forecasts of the Majority of Policy Board Members y/y % chg. Fiscal 2017 Forecasts made in October 2017 Fiscal 2018 Forecasts made in October 2017 Fiscal 2019 Forecasts made in October 2017 Real GDP CPI (all items less fresh food) +1.8 to +2.0 +0.7 to +1.0 [+1.9] [+0.8] +1.7 to +2.0 +0.7 to +1.0 [+1.9] [+0.8] +1.3 to +1.5 +1.3 to +1.6 [+1.4] [+1.4] +1.2 to +1.4 +1.1 to +1.6 [+1.4] [+1.4] +0.7 to +0.9 +1.5 to +2.0 [+0.7] [+1.8] +0.7 to +0.8 +1.5 to +2.0 [+0.7] [+1.8] Source: Bank of Japan. Note: Figures in brackets indicate the medians of the Policy Board members' forecasts (point estimates). Chart 9 CPI 2.0 s.a., y/y % chg. 1.5 All items less fresh food and energy 1.0 0.5 0.0 ▲ 0.5 All items less fresh food ▲ 1.0 CY 13 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 Source: Ministry of Internal Affairs and Communications. Note: Figures are adjusted for changes in the consumption tax rate. Chart 10 Output Gap 1.5 % Excess demand (upward pressure on prices) 1.0 0.5 0.0 ▲ 0.5 ▲ 1.0 ▲ 1.5 Excess supply (downward pressure on prices) ▲ 2.0 13/1Q 3Q 14/1Q 3Q 15/1Q 3Q 16/1Q 3Q 17/1Q 3Q Source: Bank of Japan. Note: Based on staff estimations. Chart 11 Inflation Expectations (Survey) y/y, ann. avg., % 2.5 Firms (five years ahead) 2.0 1.5 Households (over the next five years) 1.0 0.5 0.0 CY 05 Source: Bank of Japan. Notes: 1. Figures for households are from the Opinion Survey on the General Public's Views and Behavior, estimated using the modified Carlson-Parkin method. 2. Figures for firms are "Outlook for General Prices (Tankan, all Industries and enterprises, average)." Chart 12 Outlook for Price Levels Results of the 72nd Opinion Survey on the General Public's Views and Behavior (December 2017 Survey) % "Prices" will go up one year from now "Prices" will go up over the next five years 2013/Mar. Sept. 14/Mar. Sept. 15/Mar. Sept. 16/Mar. Sept. 17/Mar. Sept. Source: Bank of Japan. Note: Figures for both one year from now and over the next five years comprise the choices "will go up significantly" and "will go up slightly" that are found in the questionnaire. Chart 13 Balance Sheet of Nonfinancial Corporations tril. yen Cash and deposits 【200】 Bills and accounts receivables 【200】 Loans 【300】 Corporate bonds 【60】 Liabilities 【1,000】 Real assets (including inventories) Assets 【1,650】 【600】 Accounts payable and accrued expenses, etc. 【640】 Capital stock, etc. Investments 【250】 【450】 Internal Reserves Other 【200】 Net assets 【650】 【400】 Source: Ministry of Finance; Bank of Japan; Japan Securities Dealers Association. Note: Figures in brackets are the amount outstanding of each component at the end of fiscal 2016 (approximation). Chart 14 Investment and Personnel Expenses Investment % Investment / (operating cash flows + personnel expenses) FY 85 Source: Ministry of Finance. Notes: 1. Figures for "operating cash flows," "personnel expenses," and "investment" are based on the "Financial Statements Statistics of Corporations by Industry, Annually." Excluding "finance and insurance." 2. Operating cash flows are defined as follows: Operating cash flows = net income – dividends + depreciation expenses + Δprovisions – Δinventories – Δtrade credits – Δnet amount of other current assets. 3. Investment includes land purchasing expenses and excludes software and R&D investment. Personnel Expenses % Personnel expenses / (operating cash flows + personnel expenses) FY 85 Source: Ministry of Finance. Notes: 1. Based on the "Financial Statements Statistics of Corporations by Industry, Annually." Excluding "finance and insurance." 2. The definition of operating cash flows is the same as in the left chart. Chart 15 Bank Lending Amount Outstanding of Bank Loans (lending by domestic commercial banks) y/y % chg. Bank Lending Rates 2.0 1.8 1.6 % Bank lending rates (long-term) 1.4 1.2 1.0 0.8 0.6 0.4 -2 Bank lending rates (short-term) 0.2 -4 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Source: Bank of Japan. Note: Figures are year-on-year percent changes in the monthly average of the amount outstanding. 0.0 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Source: Bank of Japan. Note: Figures are 6-month backward moving averages.
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Speech by Mr Goushi Kataoka, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Okayama, 1 March 2018.
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March 1, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Okayama Goushi Kataoka Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices A. Recent Developments and Outlook for Economic Activity at Home and Abroad I would like to start my speech by looking at developments in the global economy affecting Japan's economy. Since the autumn of 2017, improvement in economic sentiment has been noticeable worldwide (Chart 1). The global Purchasing Managers' Index (PMI) has shown remarkable improvement for manufacturing activity in particular, and business fixed investment and trade volume have been increasing. One of the factors underlying this improvement in economic sentiment is that, while advanced economies remain robust, there is a cyclical factor of continued moderate recovery in production for the resource and manufacturing sectors, which bottomed out in 2016 amid the waning of concern over a slowdown in emerging economies, especially China. The cultivation of the potential demand by utilizing new technologies -- such as the Internet of Things (IoT), artificial intelligence (AI), and autonomous driving -- also contributes to the improvement to some extent (Chart 2). Looking at the global economy from the two perspectives of the real GDP growth rate and the inflation rate, developments can be described as follows. Until 2016, the economy remained in a phase where sluggish growth coexisted with low inflation. In 2017, it moved into a phase where an improving trend in the growth rate became evident while the inflation rate remained low. Looking ahead, the global economy is likely to shift to a phase where inflation is clearly accelerated by continued relatively high growth if various downside risks that have been pointed out, such as the following, do not materialize: (1) the risk of monetary policy normalization in the United States and Europe exerting downward pressure on the global economy; (2) the risk of deceleration in the Chinese economy; and geopolitical risks surrounding North Korea and the Middle East. One of the key points for the time being is whether the global economy will reach the phase of rising inflation with high growth that I just mentioned, while avoiding a situation of economies stalling, with major economies beginning to see changes in their monetary policy stances, and if such a phase is achieved, when that will happen. Next, I would like to turn to developments in Japan's economy. Supported by the moderate growth in the global economy, Japan's real GDP has continued to mark positive growth for eight consecutive quarters since the first quarter of 2016. The annual real growth rate for 2017 stood at 1.6 percent, the highest level since 2013 (Chart 3). The breakdown by component during this period shows that private business fixed investment and exports are the major driving forces of the growth. With regard to the outlook, in fiscal 2018, Japan's economy is likely to continue growing at a pace in the range of 1.0-1.5 percent, exceeding its potential (Chart 4). This is because business fixed investment will increase, reflecting improvements in corporate profits and business sentiment, and exports will rise on the back of robust growth in the global economy. These positive developments will then transmit more strongly than before to households through a rise in wages, which will lead to some acceleration in the pace of growth in private consumption. Meanwhile, it is highly likely that the economic growth rate for fiscal 2019 will decrease to the range of 0.5-1.0 percent, reflecting such factors as the effects of the consumption tax hike scheduled in October 2019 and (2) deceleration in business fixed investment due to the peaking out of Olympic Games-related demand. Now, I would like to talk about the effects of the scheduled consumption tax hike. The hike will have some impact on the GDP growth rates, mainly due to changes in household spending, through the following two major channels: (1) the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike and (2) the decline in real income. At present, the negative impact of the hike on the projected growth rate for fiscal 2019 is likely to be smaller than that on the rate for fiscal 2014, when the last hike took place. This is because the increase in the consumption tax rate is smaller than that of the most recent tax hike and a reduced tax rate will be applied to some items. In addition, as the consumption tax hike is scheduled to take place in the middle of the fiscal year, there are technical factors; namely, that the front-loaded increase and subsequent decline in demand prior to and after the hike will offset each other during the fiscal year, and a decline in real income could only occur in the second half of the fiscal year. B. Recent Developments and Outlook for Japan's Prices Next, I will move on to recent price developments in Japan and their outlook. Looking at recent developments in the consumer price index (CPI), the year-on-year rate of increase in the CPI for all items less fresh food for January 2018 was 0.9 percent. However, it should be noted that the contribution of energy items was significant, at 0.5 percentage point, and in terms of the rate of increase for all items less fresh food and energy, which directly reflects domestic supply-demand conditions, the rate only stood at 0.4 percent year-on-year. Although this rate indicates a continued moderate increase, its level is still low, mainly against the background that firms' wage- and price-setting stance remains cautious so far. As for the outlook, I would like to first take a look at the Bank's baseline scenario. According to the Outlook for Economic Activity and Prices (Outlook Report) released in January 2018, inflation expectations are projected to rise as firms' stance gradually shifts toward raising wages and prices with the economy still growing at a pace above its potential and the output gap continuing to improve. It also indicates that, as a consequence, the inflation rate is likely to continue on an uptrend and increase toward 2 percent. With this mechanism operating, the inflation rate -- specifically, in terms of the median of the Policy Board members' forecasts for the year-on-year rate of change in the CPI (all items less fresh food) -- is projected to rise to around 1.8 percent through fiscal 2019, excluding the direct effects of the consumption tax hike (Chart 4). In contrast to this baseline scenario, I consider that the possibility of the year-on-year rate of change in the CPI increasing to 2 percent through fiscal 2019 is low at this point. This difference in the price outlook reflects the discrepancy in how to view the overall effectiveness of the current monetary easing policy and the functioning of the policy's transmission channels. I will elaborate on this later when I explain the conduct of monetary policy. II. Conduct of Monetary Policy In what follows, I describe the Bank's monetary policy. I would like to first explain the current framework and then present my views on policy measures necessary for achieving the Bank's price stability target. In January 2013, the Bank set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI, and has been aiming at achieving this target at the earliest possible time. The Bank also announced strengthening of policy coordination with the government by releasing a joint statement, and the two entities have been working together to overcome deflation early and achieve sustainable economic growth with price stability. Under these circumstances, the Bank introduced Quantitative and Qualitative Monetary Easing (QQE) in April 2013. Since September 2016, it has been conducting monetary policy under the framework of QQE with Yield Curve Control. This current framework for monetary policy consists of two major components (Chart 5).1 The first is yield curve control in which the Bank controls short-term and long-term nominal interest rates and thereby encourages a decline in real interest rates -- calculated as nominal interest rates minus expected inflation rates -- so as to achieve highly accommodative financial conditions and stimulate economic activity and prices. The Bank has set the short-term policy interest rate at minus 0.1 percent and the target level of 10-year Japanese government bond (JGB) yields at around 0 percent. It conducts purchases of JGBs so as to achieve these targets, thereby encouraging the formation of an optimal shape of the yield curve to achieve the 2 percent price stability target. The second component is an inflation-overshooting commitment. Under this commitment, the Bank continues 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 this target level in a stable manner. With this commitment, the Bank aims to increase its credibility among the public that it will achieve the 2 percent price stability target by ruling out the possibility of a change in the direction of monetary policy at an early stage when achievement of the target comes in sight. In my view, this monetary policy framework will lead to higher inflation, mainly through four transmission channels (Chart 6). The first is highly accommodative financial conditions In addition to the two major components, the Bank conducts purchases of risky assets -- namely, exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) -- as part of monetary policy. -- accompanying declines in real interest rates through declining nominal interest rates and in risk premia -- to bring about an improvement in the output gap. The second is the improvement in the output gap to push up the observed inflation rate. The third is the rise in the observed inflation rate resulting in higher inflation expectations through the adaptive expectation formation mechanism, which further raises the observed inflation rate. And the fourth channel is that the Bank's strong commitment to achieving the 2 percent price stability target will directly raise inflation expectations, prompting a rise in the observed inflation rate in turn. Earlier, when I described the outlook for prices, I mentioned that the possibility of the year-on-year rate of change in the CPI increasing to 2 percent through fiscal 2019 is low. This is because I still lack confidence that the four transmission channels I have just explained are operating to an effective extent whereby the inflation rate will be pushed up to reach 2 percent, even though more than a year has passed since the Bank's adoption of QQE with Yield Curve Control. Of course, the positive effects of monetary easing are likely to strengthen gradually, given that the improvement in the output gap continues. At this point, however, my view is that the momentum for a rise in inflation is not strong enough to reach 2 percent through fiscal 2019.2 To illustrate this, I plot the relationship of the output gap and the inflation rate on a graph (Chart 7). In the period after the adoption of QQE leading up to the introduction of QQE with Yield Curve Control, the slope of the trend line became somewhat steep and the line's level rose (Chart 7, red line in the left-hand panel) compared with that for an earlier period (black line in the same panel). These developments suggest that ideal changes in the economy had been taking place, implying that the effects through the second channel -- that is, the improvement in the output gap that thereby pushes up the observed inflation rate -2 For the inflation rate to increase to 2 percent going forward, I consider that it is essential to achieve a widening of the output gap that exceeds 2 percent, as well as a rise in the expected inflation rate that is greater than that observed during 2013 and 2014. This view is based on a projection of price developments derived by (1) estimating the so-called hybrid New Keynesian Phillips curve that takes the expected inflation rate, the observed inflation rate, the output gap, and the consumption tax dummy as explanatory variables and then (2) applying projections of the output gap -- deduced from the forecasts of the majority of the Bank's Policy Board members on real GDP growth -- and the expected inflation rate. had been enhanced, and that both the third and the fourth channels had begun to operate following a rise in inflation expectations. Taking a look at developments since the October-December quarter of 2016, when the Bank introduced QQE with Yield Curve Control, however, the slope of the trend line has become gradual and the line's level has declined slightly, although these changes should be regarded as being subject to a margin of error due to a limited sample size (Chart 7, green line in the left-hand panel). This suggests the possibility that, although the first channel has been operating, the other three channels have not yet been doing so to their full extent.3 In other words, under the current monetary policy framework, supply-demand conditions are tightening further, but this has not yet affected firms' overall price-setting stance toward raising prices.4 It also should be noted that the rise in inflation expectations remains moderate, partly reflecting the moderate pace of increase in the observed inflation rate. Short-term inflation expectations have increased somewhat, due mainly to the rise in crude oil prices, but they have not recovered to the level seen in the period between mid-2014 and mid-2015, when such expectations shifted from increasing to being flat. Medium- to long-term inflation expectations remain somewhat weak (Chart 8). I would note that the inflation-overshooting commitment was effective in stopping a decline in inflation expectations, but it has not been sufficient to clearly increase inflation expectations. On the basis of such understanding, I believe that further monetary easing is necessary to achieve the price stability target at an early stage. Specifically, the Bank should purchase JGBs so that yields on JGBs with maturities of 10 years and longer will broadly be lowered further. With a view to reinforcing the inflation-overshooting commitment, the Bank should also add the commitment that, in terms of the medians of the Policy Board members' These facts also can be confirmed from an estimate of the Phillips curve with time-varying parameters (Chart 7, the right-hand panel). The output gap estimated by the Bank's Research and Statistics Department became positive from the October-December quarter of 2016 and has increased further to 1.35 percent in the July-September quarter of 2017. Having said that, a further widening of the output gap is necessary to affect firms' overall price-setting stance toward raising prices, in view of the fact that the average of the output gap was in the range of 2.5-3.0 percent in the past when the year-on-year rate of increase in the CPI (all items less fresh food and energy) exceeded 2 percent on a basis excluding the effects of consumption tax hikes. forecasts presented in the Outlook Report, if there is a delay in the timing of achieving the price stability target due to domestic factors, the Bank should take additional easing measures. I would note that a further lowering of yields on JGBs with maturities of 10 years and longer will promote business fixed investment and housing investment to a greater extent from the financial side. This lowering of JGB yields is also expected to have synergy effects with the government's fiscal policy providing tax support for firms that have a positive stance toward making fixed investment and raising wages. These developments will further increase the pace of improvement in the output gap, and thus enhance the dynamism of the rise in the inflation rate through the first and second transmission channels that I explained earlier. Among many options for additional monetary easing measures under yield curve control, the further lowering of yields on JGBs with maturities of 10 years and longer is the best at this point, in my view, considering the balance between positive and negative effects. Strengthening of the inflation-overshooting commitment aims at increasing the transmission effects of higher inflation expectations on the observed inflation rate -- in other words, increasing the effects through the third and fourth transmission channels. The rise in inflation expectations from 2013 was attributable to the Bank's decision to introduce an inflation targeting policy. It also was attributable to the initiatives taken to achieve the policy; the Bank announced the strengthening of policy coordination with the government by releasing the joint statement, and the two entities have taken concrete actions by implementing flexible fiscal policy and bold monetary policy as well as the growth strategy. In order to influence inflation expectations, it is essential that policy coordination with the government aiming at achieving the price stability target be firmly ensured through both entities' concrete actions. The Bank, for its part, should further promote powerful monetary easing backed by a clear and strong commitment to achieving the price stability target. III. Reason for Importance of Achieving and Maintaining the Price Stability Target As the global economy continues to grow at a moderate pace, the Federal Reserve is on course to raise policy interest rates and the European Central Bank is moving toward an exit from monetary easing. Under such circumstances, there is some speculation, especially overseas, that Japan's monetary policy might also shift to a tightening in the near future, or might at least make a slight adjustment toward an exit from monetary easing. However, the inflation environment in Japan differs substantially from that in the United States and major countries in Europe. I believe that, in Japan, there is still a long way to go before considering a change in monetary policy stance. Let me first look at price developments in Japan as well as in the United States, where the policy rate hike is proceeding. Chart 9 compares developments in the inflation rate excluding those of fresh food and energy between Japan and the United States since 1995. The bold black line indicates an inflation rate of 2 percent and the gray bands show recession periods. In the United States, the inflation rate has been more or less at around 2 percent from 1995 to the present. On the other hand, in contrast to the United States, the inflation rate in Japan moved in negative territory for most of the time during the period between the latter half of 1998 and early 2013. In 2013 onward, the inflation rate has turned positive, mainly due to the introduction of QQE, but remains distant from 2 percent. Such a difference in price developments between Japan and the United States is often compared to the existence or absence of an anchor that stabilizes a ship in the ocean. The inflation rate generally fluctuates with volatilities of and shocks to the macroeconomics and market conditions, such as crude oil price changes. In the United States, however, the inflation rate has returned to close to 2 percent even after major shocks such as the global financial crisis following the failure of Lehman Brothers. This is because people's inflation expectations are firmly fixed, just as a ship is anchored, at around 2 percent.5 In my view, the reason why incremental policy rate hikes have been possible in the United States so far is that inflation expectations are judged to be anchored well. In Japan, on the other hand, firms' and households' mindset has been formed under the prolonged deflationary environment after the mid-1990s, such that economic activity assuming no inflation has For the implications of inflation expectations being anchored, see Ben Bernanke, "Inflation Expectations and Inflation Forecasting: Speech at the Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, Massachusetts," Federal Reserve Board (July 2007). become rational. In other words, Japan has lost the anchor for inflation expectations and has been stuck in a deflationary equilibrium.6 The Bank, through its bold monetary easing policy, now aims at shifting the economy from being stuck in a deflationary equilibrium to entering an inflationary equilibrium in which inflation expectations are anchored at around 2 percent. However, as I have explained so far, the improvement in the inflation rate is not enough and still only halfway accomplished. If the direction of monetary policy is changed without deep consideration in such a situation, there is a risk of the economy fully returning to a deflationary equilibrium. After the introduction of QQE in April 2013, inflation expectations rose steadily toward 2 percent. However, the momentum weakened, stemming from the consumption tax hike and the fall in crude oil prices. Subsequently, a headwind -- that is, a slowdown in emerging economies and instability in global financial markets -- led to sluggishness in inflation expectations. This experience suggests that, at the stage where the 2 percent price stability target is not yet achieved, inflation expectations are susceptible to negative economic shocks and the economy could easily return to a deflationary equilibrium.7 That is the very reason why it is necessary to carefully conduct the current monetary policy by giving full consideration to risks to economic activity and prices. 8 Going back to my See James Bullard, "Seven Faces of 'The Peril'," Federal Reserve Bank of St. Louis Review, vol. 92, no. 5 (2010): 339-52. Based on Japanese and U.S. data for 2002-2010, Bullard discusses the possibility of the U.S. economy at that time falling into a deflationary equilibrium like Japan, and analyzes monetary policy so as to avoid such equilibrium. See Ryan Banerjee and Aaron Mehrotra, "Deflation Expectations," BIS Working Papers, no. 699 (February 2018). The authors found that, by analyzing inflation expectations across 43 economies, expectations become "less well anchored" and are associated with "somewhat higher backward-lookingness" during deflations. In assessing the effects of large-scale monetary policy on the financial system and the functioning of financial intermediation, multiple factors also should be taken into account; for example, effects of developments in lending rates, (2) declines in firms' bankruptcy rates and in banks' credit costs, both resulting from monetary easing, and (3) effects of improvement in asset markets pushing up financial institutions' profits. When making monetary policy decisions, it is necessary to give due consideration to the likelihood that the longer it takes to achieve the price stability target, the more risks to the robustness of the financial system arise. earlier reference to recent developments and the outlook for economic activity and prices, from the perspective of careful conduct of monetary policy, I believe that the following two points require due attention, particularly with regard to the assessment of economic developments in fiscal 2019. The first point to be considered is that, since the most recent consumption tax hike in fiscal 2014, a rise in real disposable income has not strongly linked to an increase in real consumption. It should be noted that, if the next consumption tax hike scheduled in October 2019 causes similar effects, improvement in aggregate demand will not make sufficient progress. I also would note the possibility that, if the tax hike takes place when the anchor of inflation expectations is not yet functioning effectively, people's inflation perceptions might change and, mainly due to declines in consumption, inflation expectations might become sluggish again.9 That is, there is a possibility that the tax hike could increase downward pressure on prices through both channels of the output gap and inflation expectations (Chart 10). The second point is that there is some possibility that risks to developments in overseas economies will materialize by fiscal 2019. If the risks materialize, Japan's economy will slow down to some degree as it loses support from the firm growth in the global economy. In my view, particular attention should be paid to the risk that U.S. monetary policy normalization will put downward pressure on the global economy, as its potential impact on the global economy is larger than that of other risks. As for the impact of the tax hike on the inflation rate and inflation expectations, one possibility is a decline in aggregate demand to push down the observed inflation rate, which will lower inflation expectations in turn. Another possibility is a rise in prices accompanied by the tax hike to raise inflation expectations. Earlier episodes of tax hikes in April 1997 and April 2014 suggested that the inflation rate initially rose following each hike but declined as aggregate demand decreased, thereby causing a fall in inflation expectations. Following the bursting of the bubble in the 1990s, Japan experienced a prolonged period of economic stagnation aggravated by deflation, described as the "lost two decades."10 Since 2013, the price situation is finally no longer deflationary, owing to the improvement in the environment surrounding firms and households -- such as represented by the employment situation -- in addition to the Bank's implementation of bold monetary easing policy.11 While Japan's economy is still on its way toward achieving and maintaining the price stability target, as I described earlier, it is necessary to augment the momentum of the virtuous cycle that has emerged during the process toward achieving this target, and put an end to the "lost two decades" for good by realizing the target at an early stage. As a member of the Policy Board of the Bank, I will continue to devote the best of my abilities toward achieving and maintaining the price stability target. Thank you for your attention. For details about Japan's prolonged stagnation, see the following publications: (1) Koichi Hamada, Anil Kashyap, and David Weinstein, Japan's Bubble, Deflation, and Long-term Stagnation (Massachusetts: The MIT Press, 2010); (2) Masazumi Wakatabe, Japan's Great Stagnation and Abenomics: Lessons for the World (New York: Palgrave Macmillan, 2015); and (3) Kataoka Goushi, Nihon no "Ushinawareta 20-nen": Defure o koeru keizai seisaku ni mukete [Japan's Lost Two Decades: For economic policies to overcome deflation] (Tokyo: Fujiwara-Shoten, 2010). See Adachi Seiji, "2 pāsento no infure mokuhyō wa datō ka" [Is an inflation target of 2 percent appropriate?], Keiki to Saikuru (Japan Association of Business Cycle studies), no. 64, November 2017. Adachi estimates a New Keynesian Phillips curve by adopting the framework of the Logistic Smooth Transition Autoregressive model, on the assumption of two regimes; namely, a "deflationary regime" and an "inflationary regime." Looking at the estimates on the probability of a regime change, the figure for the April-June quarter of 2017 is estimated at 57.8 percent. While this is greater than 50 percent -- the threshold between the "deflationary regime" and the "inflationary regime" -- it suggests that the economy is still distant from 100 percent, a level that would indicate the economy's complete overcoming of deflation. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Okayama March 1, 2018 Goushi Kataoka Member of the Policy Board of the Bank of Japan Chart 1 Global Economy Projections of Real GDP Growth by Major Economies (as of January 2018) Global PMI DI, % pts. y/y % chg., % pts. Global Manufacturing PMI Output Index Projection for CY 2018 Revision World 3.9 +0.3 Advanced economies 2.3 +0.3 United States 2.7 +0.2 Euro area 2.2 +0.6 4.9 +0.1 6.6 +0.6 Global Services PMI Business Activity Index Emerging market and developing economies China CY 13 Note: Figures are from the J.P. Morgan Global PMI. Figures above 50 indicate improvement and below 50 show deterioration on a month-on-month basis. Source: IHS Markit (© and database right IHS Markit Ltd 2018. All rights reserved.). Note: Figures in the column “Revision” indicate differences from the projections as of January 2017. Source: IMF, “World Economic Outlook Update, January 2018.” Chart 2 Global Economy Global Semiconductor Demand by End Use bil. USD Automotive Industry, etc. Consumer Computer, etc. Communications CY 13 CY 16 Note: “Communications” includes smartphones, “Computer, etc.” includes PCs and data centers, “Consumer” mainly represents household electrical appliances, and “Industry, etc.” includes industrial robots. Source: Semiconductor Industry Association, 2017 and 2014 Factbook. Chart 3 Japan’s Economy Real GDP Growth and Breakdown by Component ann., q/q % chg. Private consumption Government spending Imports Real GDP Private business fixed investment, etc. Exports Change in inventories, etc. -5 -10 -15 CY 1313 CY 15 15 16 16 Source: Cabinet Office, “Quarterly Estimates of GDP for October-December 2017 (First Preliminary Estimates).” 17 17 Chart 4 Japan’s Economy Medians of the Policy Board Members’ Forecasts (as of January 2018) y/y % chg. Real GDP FY 2017 Forecasts made in October 2017 FY 2018 Forecasts made in October 2017 FY 2019 Forecasts made in October 2017 CPI (all items less fresh food) Excluding the effects of the consumption tax hike +1.9 +0.8 +1.9 +0.8 +1.4 +1.4 +1.4 +1.4 +0.7 +2.3 +1.8 +0.7 +2.3 +1.8 Notes: 1. Figures indicate the forecasts (point estimates) presented in the January 2018 Outlook Report. 2. The consumption tax hike scheduled to take place in October 2019 (to 10 percent) and the reduced tax rate to be applied to food and beverages (excluding alcohol and dining-out) and newspapers are incorporated in the forecasts. Source: Bank of Japan. Chart 5 QQE with Yield Curve Control Yield Curve Control Inflation-Overshooting Commitment JGB yield (%) Inflation rate (%) Target level of 10-year JGB yields: around 0 percent 2% Short-term policy interest rate: minus 0.1 percent Residual maturity (year) Time Continuation of monetary base expansion Chart 6 Transmission Channels of Monetary Easing to Prices Reinforcement of Commitment Decline in Nominal Interest Rates and Risk Premiums Declining real interest rates through declining nominal interest rates Facilitating private investment Stabilizing financial markets Improving credibility in inflation targeting policy Exerting synergy effects with fiscal policy Improvement in Output Gap Increasing upward pressure on wages Improving labor market conditions Raising capital utilization rates Rise in Inflation Expectations Adaptive formation of inflation expectations Greater increases in base wages Facilitating cost pass-through Realization of inflation expectations Increasing effectiveness of monetary easing Increase in Inflation Rate Achievement and Maintenance of the Price Stability Target Chart 7 Output Gap and Inflation Rate Reference: Intercept and Slope of the Phillips Curve Output Gap and Inflation Rate % Before QQE with Yield Curve Control Apr. 2013-Sept. 2016 Inflation Rate 1.2 % Intercept 0.25 Slope (right axis) After QQE with Yield Curve Control Oct. 2016-Dec. 2017 Introduction of Yield Curve Control (September 2016) Introduction of QQE (April 2013) 0.8 0.20 0.4 0.15 0.0 0.10 -0.4 0.05 Oct. 1999-Mar. 2013 -1 -2 -8 -6 -4 -2 Output Gap (3-quarter lagged) % Notes: 1. Trend lines are determined as <Inflation Rate> = Intercept + Slope * <Output Gap [-3]>. 2. Inflation rate (vertical axis) shows year-on-year growth in the CPI (all items less fresh food and energy). 3. Output gap (horizontal axis) is lagged behind the inflation rate by 3 quarters. Figures are estimated by the Research and Statistics Department of the Bank of Japan (lag is determined by timing correlation). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. -0.8 CY 10 0.00 Notes: 1. Figures are estimation results of the Phillips curve obtained by employing time-varying intercepts and slopes in the left-hand panel. Estimation period is from January 1983 through December 2017. 2. Output gap is lagged by 3 quarters (lag is determined by the AIC). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 8 Inflation Expectations Firms’ Inflation Expectations (Tankan) 2.0 y/y % chg. Synthetic Indicators of Inflation Expectations Obtained through Principal Component Analysis (Medium- to Long-Term) 2.0 y/y % chg. Consensus Forecasts QUICK Survey Inflation swap rate 1.5 1.5 1.0 1.0 0.5 0.5 1-year horizon 3-year horizon 5-year horizon 0.0 CY 14 0.0 CY 10 Notes: 1. Lines in the left-hand panel show the average outlook for general prices for all industries and enterprises released in the Tankan. 2. Inflation expectations of firms, households, and experts are synthesized in the right-hand panel. Inflation expectations of firms are represented by the Tankan and those of households are represented by the Bank’s Opinion Survey on the General Public‘s Views and Behavior. For experts’ inflation expectations, data from the Consensus Forecasts, the QUICK Survey, and the inflation swap rate are used, which is shown as the different lines respectively. 3. Semiannual data from the Consensus Forecasts up through 2014/Q2 are linearly interpolated. Figures for the Opinion Survey exclude inflation expectations by respondents whose annual inflation expectations were ±5% or greater. 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”; QUICK, "QUICK Monthly Market Survey (Bonds)"; Bloomberg; Bank of Japan. Chart 9 Comparison of Inflation Rates in the United States and Japan Japan United States % % -1 -1 -2 CY 95 -2 CY 95 Notes: 1. Red dots show year-on-year changes in the PCE deflator (all items less fresh food and energy) for the United States, and those in the CPI (all items less fresh food, energy, and excluding direct effects of consumption tax hikes) for Japan. 2. Bold black lines indicate inflation rate of 2 percentage points. 3. Black broken lines indicate average inflation rate after CY 95 (discontinued at the introduction of QQE for Japan). 4. Gray bands indicate recession periods (peaks and bottoms of business cycle are those determined by the National Bureau of Economic Research for the United States and Cabinet Office for Japan). Sources: Cabinet Office; Ministry of Internal Affairs and Communications; Federal Reserve Bank of St. Louis; National Bureau of Economic Research. Chart 10 Consumption before and after Consumption Tax Hike Real Disposable Income and Real Consumption Expenditures CY 2015=100 Average Consumption Propensity FY 2000=100 System of National Accounts Family Income and Expenditure Survey Real Consumption Expenditure Consumption tax hike Before most recent consumption tax hike (Jan. 2000-Mar. 2014) After most recent consumption tax hike (Apr. 2014-Dec. 2017) FY 2000 Real Disposable Income CY 2015=100 Note: Data are for workers’ households with two or more members. Source: Ministry of Internal Affairs and Communications, ”Family Income and Expenditure Survey.“ 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. Average Consumption Propensity = Household Consumption Expenditure / Household Disposable Income. 2. Disposable income for National Accounts includes that of private unincorporated enterprises. 3. Figures for the Family Income and Expenditure Survey are those for the average of each fiscal year (average of April to December for 2017). Sources: Cabinet Office, “System of National Accounts”; Ministry of Internal Affairs and Communications, ”Family Income and Expenditure Survey.“
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Dinner meeting hosted by Deutsche Bundesbank Regional Office in Berlin and Brandenburg, Berlin, 9 January 2018.
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Januar y 9, 2018 Bank of Japan Germany and Japan — A Central Banker's Perspective on their Past and Future Relationship Speech at the Dinner meeting hosted by Deutsche Bundesbank Regional Office in Berlin and Brandenburg Hiroshi Nakaso Deputy Governor of the Bank of Japan Introduction Vielen Dank für Ihre sehr freundlichen Worte. Es ist mir eine große Freude und Ehre, hier heute im schönen Berlin und Brandenburg vor Ihnen sprechen zu dürfen! Ich würde mir wünschen, meine Ansprache weiter auf Deutsch halten zu können. Um Ihnen aber meine Gedanken besser vermitteln zu können, werde ich nun auf Englisch fortfahren. (Thank you very much for your kind words. It is my pleasure and honor to speak to you here today in the beautiful city of Berlin and Brandenburg. I wish I could go on with the speech in German. But in order to better convey my thoughts to you, I will now continue in English.) I. Relationship between Germany and Japan Germany and Japan have a longstanding diplomatic relationship of more than 150 years. I think the phrase that best describes this is Ferne Gefährten (distant companions). This is because we have many things in common, although our countries are geographically distant. The diligence of our populations has overcome limitations of natural resources, transforming our two countries into economic powers. Today, the labels ''made in Germany'' and ''made in Japan'' are a guarantee of quality and excellence. And as mature economies, we face similar challenges in the future, with societal aging being one example. The central banks of Germany and Japan also developed a friendship over the years. The Bank of Japan established an office in Frankfurt am Main in 1956. The Bundesbank opened its Tokyo office in 1987, as the only overseas office besides New York. In 2012, the role of the Tokyo office was expanded to include foreign exchange reserve management. The history of our bilateral relationship traces back to the time of the Reichsbank and the Bank deutscher Länder. In this context, let me tell you an extraordinary story involving a former governor of the Bank of Japan. II. Mr. Mayekawa's Extraordinary Experience In the very early part of my career at the Bank of Japan, I worked for Mr. Haruo Mayekawa. He was a legendary central banker who served as the 24th Governor of the Bank of Japan, from 1979-84. He passed away in 1989 but is still remembered as the man who brought the Bank of Japan back into the international central banking community during the post-war era. His long international experience, which dated back to the prewar period, won the trust of his fellow central bankers. In October 1988, I had a chance to dine with Mr. Mayekawa and his wife at a traditional German restaurant in Berlin. He was invited as a special guest to the International Monetary Fund (IMF) Annual Meeting held here in Berlin that year. Over a good wine, he became a little more eloquent than usual and started to tell us the following story. Berlin was a special place, he began. The Bank of Japan, after its foundation in 1882, had established several overseas offices. In 1941, Mr. Mayekawa was assigned to the Bank of Japan's Rome Office. World War II had broken out. After the surrender of Italy, he moved to the Bank of Japan's Berlin Office, where he stayed until the final days of the war in Europe. He described to us what life was like in the bunkers of Berlin in those days. Then, after the fall of Berlin, he fled via the Siberian Railway to Manchuria, a part of China under Japanese control at the time. From there he took a ship back to Japan. Had he decided to remain in Manchuria, he might have been caught up in the military offensive by the Soviet Union following its declaration of war on Japan in August 1945. When Mr. Mayekawa finally returned home and stood in his doorway, Mrs. Mayekawa told us, she was so surprised that she first looked to see whether he had feet -- because in Japan it is thought that ghosts do not have feet. She had assumed he was no longer alive, because he had been reported missing. Mr. Mayekawa is probably the only governor in the history of central banking who experienced three unconditional surrenders in wartime; in Italy, Germany, and then in Japan. At the restaurant, looking at the colorful and prosperous lights of the Kurfürstendamm, he concluded his story by telling us how much he cherished peace and how much he thought sound economic development mattered. Let me add that for me, too, personally, Germany is a very familiar place. As a young boy in the late 1960s, I was brought up in beautiful Hansestadt Hamburg. It was during this period that my father took me to West Berlin for the first time. My second visit was in 1988, when, as I mentioned, the IMF held an annual meeting in West Berlin and I attended the Japanese delegation. So, this is my third visit. But this visit is very special as it is my first one to the capital city of the united Germany. III. Origins of Japan's Economic Ordeal The two central banks, the Bundesbank and the Bank of Japan, have had the reputation as tough inflation fighters. However, the policy priority started to diverge in the 1990s. Our mission became focused on ending deflation and bringing Japan's economy back on track to sustained growth. This is the topic that I now want to talk about. Let me begin with the background to the difficulties that Japan has faced. I think the root cause of Japan's economic ordeal is the bursting of asset bubbles in the early 1990s. Slide 1 looks at the magnitude of the bursting of asset bubbles. As you see in the left panel, the cumulative capital gains during the bubble years in Japan amounted to more than 450 percent of nominal GDP. The bursting of the bubble resulted in a brutally large swing in the opposite direction, with the cumulative capital losses equivalent to almost minus 230 percent of nominal GDP. In the United States, which was the epicenter of the Global Financial Crisis, the corresponding numbers were 300 percent and minus 100 percent, respectively. In both cases, the economic impacts were destructive. In Japan's case, the toll was almost exclusively on the banking sector, which often had been compared to the Invincible Armada during the bubble era. Slide 2 shows the cumulative credit losses experienced by Japanese banks. This figure climbed constantly until it reached almost 100 trillion yen, which corresponds to about 20 percent of Japan's nominal GDP. During the decade of Japan's financial crisis, more than 180 financial institutions, including internationally active ones, went under. The banking sector was broken. This meant the loss of the credit intermediary function, which was badly needed at the time to support economic recovery. When Japan's economy overcame the aftermath of the homegrown financial crisis of the 1990s, it was struck by another major shock, triggered by the U.S. subprime loans problem and accentuated by the collapse of Lehman Brothers: the Global Financial Crisis. The left panel in Slide 3 shows that the parallel shift of GDP to the downside took place in Japan. This also was the case for other major economies, including the U.S. economy. Although the GDP recovered to pre-crisis levels, for reasons we do not precisely know, it has not returned to the original trends in the Japanese economy and many other advanced economies. On the contrary, the German economy, which you see in the right panel, was exceptional in that it reverted to the original trend rather quickly with higher growth rates. The difference may be an interesting topic to be further explored. Therefore, the financial crisis was the root cause for Japan's ordeal. But the country's problem was compounded by other factors; namely, deflation and demography. Slide 4 shows Japan's potential growth rate with a solid red line and its determinants in bars of different colors. The protracted period of deflation that lasted for almost 15 years after the homegrown financial crisis in the 1990s prevented firms from investing in capital, and capital input remained sluggish because the corporate strategy under deflation was to sit on cash. Meanwhile, labor input has negatively contributed since the 1990s as a result of the shift in demographics. This has much to do with Japan's aging society, where the birth rates remained low and the baby boomers reached their retirement age. As the solid red line in the graph shows, the potential growth rate in Japan has been on a declining trend, coming down from around 4 percent in the late 1980s to almost 0 percent before bouncing back to 0.8 percent recently. What this chart implies is that, in order to elevate Japan's potential growth rate, we need to raise all three determinants: total factor productivity (TFP), labor input, and capital input. Another way of expressing this is that we need to raise labor productivity and labor input in order to elevate Japan's potential growth rate. Slide 5 provides a decomposition of Japan's GDP growth rates into labor productivity growth and rate of change in the number of employed persons. It is quite obvious from the chart that the decline in labor force forecast for the next decades must be more than offset by improvement in labor productivity if the Japanese economy is to maintain positive growth. What this chart suggests is that, for a country like Japan, or any country with a shrinking population, improving labor productivity is the number one policy priority. An interesting question in this regard is how Japan's situation compares with Germany, the economy of which is known to face similar demographic challenges sooner or later. Slide 6 compares the economic performances of Japan and Germany over the last decade, from 2006 through 2016, and the contributing factors. The average annual economic growth rate in Germany was 1.5 percent, which was more than twice as high as Japan's growth rate of 0.6 percent during the same period. The improvement in labor productivity was more or less equivalent in both economies. The major difference appears to be in terms of labor input. While labor input declined in Japan, it has shown positive growth in Germany. Slide 7 shows why this is the case. While the hours worked by an employed person declined in both economies, falls in the unemployment rate and increases in the labor force participation rate have been more pronounced in Germany than in Japan as far as this period is concerned. But challenges lie ahead for both economies. The right panel in Slide 8 shows that Japan has already turned into what is called a "population onus society," in which the working age population declined at a faster pace than the total population. As the left panel suggests, this is forecast to be followed by Germany, albeit in a less conspicuous manner, in the coming decades. The decline in the working age population may be partially offset by an increase in the number of foreign workers. This seems to typically have been the case with Germany, which you see in the panel of Slide 9. Even for Japan, the number of foreign workers has climbed in recent years by more than one million against the backdrop of an acute labor shortage. Even if a decline in the working age population is inevitable, the negative impact on labor input can be mitigated by raising labor participation rates. In this regard, Japan has made tangible achievements in recent years. Slide 10 offers an international comparison of labor force participation rates. The lower left panel shows Japan's labor participation rate for women by age group over the past two decades. You see that more women in the age group of 25-34 years (typically young working mothers) work today than ever before, offsetting the overall decline in the working age population. The labor participation rate for this age group has climbed to 77 percent in 2016, and as a result, the notorious M-shaped curve largely has been corrected. An international comparison shown in the lower right panel reveals that Japan's participation rates for women in 2016 are generally higher than in the United States, although not as high as in Germany or Sweden. Thus, of the two supply-side determinants of economic growth, labor input can be upheld by raising labor participation rates. What about the other determinant, labor productivity? Slide 11 provides us with some insight. The left panel compares the level of labor productivity in the G7 countries. If you place the U.S. productivity level as the benchmark at 100, Japan's productivity level is around 70 percent of the U.S. level. The German productivity level stands highest in the G7 economies. Thus, for Japan to catch up to the U.S. productivity level, it has to close a gap that amounts to 30 percent. As a matter of fact, the right panel shows that Japan achieved one of the highest productivity growth rates among the G7 countries between 2000 and 2015. This suggests that there does remain room to catch up, and it is actually catching up. We know that our manufacturing companies are competitive on a global standard. So, it is mainly the services industries that need to accelerate their catch-up process, possibly through a wider use of information and communication technologies. IV. Bank of Japan's Monetary Policy Now let me talk about the monetary policy. The Bank of Japan did not just sit by and watch Japan's economic difficulties. In fact, as the nation's central bank, we went through an all-out struggle. Slide 12 shows that the problem with Japan was that the policy rate had reached 0 percent in the early 2000s long before other central banks in the major economies faced the same problem. This meant that there was no room for the Bank of Japan to reduce the short-term policy rate. Japan was faced with the zero-lower bound ahead of other industrialized economies. When room for further policy rate cuts was exhausted, we introduced a number of new monetary policy measures that are described today as unconventional monetary policies. The Bank of Japan originated quantitative easing and was the first to employ forward guidance. We have literally been an inventor of various sorts of new forms of monetary policies. The latest version of such new policies is called Yield Curve Control (YCC). Slide 13 shows the outline of the policy. It intends to facilitate the formation and thus the shape of a yield curve that is considered most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent. Under YCC, the operational target is the interest rate. The novelty is that we have two target rates. The short-term policy interest rate is set at minus 0.1 percent and the target level of the 10-year Japanese government bond (JGB) yields at around 0 percent. We are buying a necessary and sufficient quantity of JGBs to maintain the rate targets. I think the policy has been quite effective. The left panel in Slide 14 shows that Japan's yield curve generally stays lower than those in the United States and Germany. A comparison with the German yield curve reveals that, while shorter rates are lower in Germany, long-term rates are kept lower in Japan than in Germany. The right panel compares 10-year bond yields in the major economies. While the U.S. Treasury rates moved up after the presidential election in November 2016, dragging the German Bunds rates in the same direction, the JGB yields remained at lower levels under YCC. I now turn to economic and inflation development in Japan to show that the monetary policy has worked quite effectively. Slide 15 provides the Bank of Japan's latest economic and inflation outlook. As you see in the table, Japan's economy is forecast to grow 1.9 percent in fiscal 2017 and 1.4 percent in fiscal 2018. This is well above Japan's potential growth rate, which is estimated to be around 0.8 percent. Therefore, the output gap is expected to improve further into positive territory. This is supposed to exert upward pressure on prices. However, on the inflation front, consumer price index (CPI) inflation rates remain weak and are only expected to reach 1.8 percent in fiscal 2019, still falling short of the price stability target of 2 percent. In the meantime, the economy has never been better balanced in the recent past. As we see in the left panel of Slide 16, corporate profits have climbed to record high levels. The labor market is very tight with the unemployment rate, shown in the middle panel, all the way down to 2.7 percent, which implies full employment. Meanwhile, job opening rates, as shown in the right panel, rose to historically high levels. So, the question is why the prices are so weak when the macroeconomic fundamentals are so favorable. As a matter of fact, this may be a common question to be asked of the economies of the United States and the Euro area. My answer to the question in Japan is that, against the backdrop of acute labor shortage, corporate firms in Japan are trying to absorb wage cost pressures without passing them on to sales prices, through such measures as labor-saving capital expenditure, and streamlining their business processes, by doing away with excessive or unnecessary services. In both cases, labor productivity improves and exerts downward pressure on inflation. As a matter of fact, as you see in the left panel of Slide 17, a macroeconomic perspective tells us that labor productivity is on a steady upward trend recently, while real wages are moving almost sideways. Thus, the gap between them, which we label the real wage gap, has declined, as you see in the right panel. This means that real wage increases have not caught up with improvements in labor productivity. In sum, I think weak inflation in Japan has to do with higher productivity, which can be regarded as a supply-side shock. Assuming that wages eventually catch up with labor productivity improvement and the wage gap reverts to zero over time, we can expect inflation rates to pick up accordingly. I think it is a matter of time before we start to witness inflationary pressures gather momentum. To the extent that good things are happening to the economy, I think we do not need to be overly frustrated about the low inflation. We can be patient and continue with the current monetary policy without any further easing. V. Lessons from the Japanese Experience What lessons, if any, does the Japanese experience have for the Euro area, which now faces similar challenges ranging from low inflation to demographics? I wish I could offer you a full answer, but our own mission to overcome deflation and bring the economy back on track toward sustained growth is not fully completed. So, what I'll offer here are three interim suggestions. First, you definitely need to avoid a financial crisis. We have learned that a financial crisis inflicts lasting damage on the economy. Therefore, it is essential that the soundness of the financial system is maintained through adequate regulation and supervision. It is just as important to have an operational safety net, including a deposit insurance system and resolution framework that prevents a failure of a financial institution from developing into a systemic crisis. In this regard, the completion of the Basel III regulatory reforms that began following the onset of the global financial crisis is a significant achievement. Second, monetary policy alone cannot achieve the ultimate goal of overcoming deflation and bringing the economy back on track to sustained growth. Monetary policy must be pursued in tandem with the growth strategy, or structural policies more broadly. Monetary easing raises potential GDP through an increase in the capital stock as well as labor input, thus affecting the supply side. Moreover, accommodative monetary conditions should mitigate any frictional costs that might otherwise accompany the necessary structural reforms. What we in Japan and the Euro area have in our hands is a golden opportunity to upgrade our economies. We should not miss this chance to promote much needed structural reforms. Third, the central bank needs to maintain its credentials as a deflation fighter as much as an inflation fighter by showing a clear and unequivocal commitment to battle deflation. Should this be lost, our experience suggests that the credentials would be extremely difficult to recover. I am sure that the policy makers in the Euro area, including the Bundesbank, recognize precisely these points and therefore require no advice from me. The cumulative wisdom we have built up over the years in addressing the challenges should collectively and fully be utilized in guiding our economies in the right direction. Closing Remarks One summer day in the late 1960s, when I lived in Hamburg, my father drove me to the border of what was then the Deutsche Demokratische Republik (DDR). At the border in the middle of a meadow, a Bundeswehr border guard approached me and said ''Look boy, also beyond here is Germany—auch drüben ist Deutschland.'' What Germany has achieved since then is a truly admirable Wirtschaftswunder (economic wonder). I understand it has embarked on the ''Industrie 4.0'' initiative to create yet another Wirtschaftswunder. In the five decades since my boyhood in Germany, the social and economic environments in both countries have changed quite dramatically. Today, an average Japanese person has a life expectancy that is 15 years longer than people did in 1960. An average Japanese worker today works 50 hours less per month compared with 1960. Similarly, in Germany, life expectancy today is 13 years longer and a German worker works 70 hours less compared with 1960. This is a big change for the people in the two countries, whose common virtue used to be diligence in the 1960s. But this is not necessary a bad thing, because people have more time to enjoy life. It also means that we have more time to get to know each other even better. I have a father, who is now fully retired and is one of those enjoying longer life. When I visited him over the New Year holiday, he told me he still regularly exchanges updated family history with his alten Kameraden (old comrades) fifty years on since his days in Germany. Old friendship never dies. I now know it is the responsibility of our generation to not just inherit the friendship with Germany, but foster it and pass it on to the generations to come. Thanks to technological innovation, we can learn a lot more easily about each other's history and culture these days. In addition, traveling has become far easier, enabling ''seeing is believing'' for many people. Thus, I believe the relationship between Germany and Japan is entering a new stage beyond the traditional sphere, where economic and cultural interaction has become an everyday affair, making geographical distance less meaningful. I would like to conclude my speech this evening by expressing my sincere hope that our friendship develops from Ferne Gefährten (distant companions) to what can be called Enge Gefährten (close companions). This concludes my speech this evening. Ich danke Ihnen für Ihre Aufmerksamkeit. (I thank you for your attention.) Germany and Japan A central banker’s perspective on their past and future relationship Speech at the Dinner meeting hosted by Deutsche Bundesbank Regional Office in Berlin and Brandenburg January 9, 2018 Hiroshi Nakaso Deputy Governor of the Bank of Japan Slide 1 Scale of Asset Price Bubbles Japan United States ratio to nominal GDP, % ratio to nominal GDP, % Financial assets Financial assets Real estate Real estate ▲ 100 ▲ 100 ▲ 208 ▲ 200 ▲ 102 ▲ 200 ▲ 20 ▲ 228 ▲ 300 CY 1986-1990 ▲ 54 ▲ 48 1991-2000 ▲ 300 CY Note: Ratios are derived from the cumulative sum of capital gains and losses from each year. Sources: Cabinet Office; FRB; BEA. 2003-2007 2008-2012 2008-Present Slide 2 Loss on Disposal of Non-performing Loans Among Japanese Financial Institutions % （％） （兆円） tril. yen Loss on disposal of non-performing loans 不良債権処分損 Nominal GDP ratio (right scale) 名目ＧＤＰ比率（右目盛） 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 03 04 05 06 07 19 92 93 FY 年度 Slide 3 Real GDP Japan Germany 2008/Q1=100 2008/Q1=100 1.29% per annum 1.14% per annum 1.83% per annum 1.29% per annum Fitted 2000/Q1-2008/Q1 Fitted 2009/Q1-2017/Q3 16 17 Fitted 2000/Q1-2008/Q1 Fitted 2009/Q1-2017/Q3 16 17 Note: The GDP series in the figures are seasonally-adjusted. Source: OECD. Slide 4 Potential Growth Rate y/y % chg. Total factor productivity Capital input Labor input Potential growth rate -1 -2 FY 85 Note: Based on staff estimations. Figures for the first half of fiscal 2017 are those for 2017/Q2. Source: Bank of Japan. Slide 5 Japan's Real GDP Growth avg., y/y % chg. Labor productivity growth (rate of growth in real GDP per employed person) Rate of change in the number of employed persons Real GDP growth rate Forecast +1.1% +0.8% +0.5% -1 -0.2% -0.0% -0.7% -1.0% -2 1970s 1980s 1990s 2000s 2010s 2020s 2030s Note: Fiscal-year basis. The rates of change in the number of employed persons from 2017 onward are calculated using the population outlook (medium variant) and projected labor force participation rates (assuming the labor force participation rate for each age/sex group remains the same as in 2016). Sources: Cabinet Office; Ministry of Internal Affairs and Communications; National Institute of Population and Social Security Research. Slide 6 Real GDP 2006-2016 avg., y/y % chg. 2.5 Labor input Labour input Labour productivity Labor productivity 2.0 Real GDP 1.5 1.5 1.0 0.5 0.6 0.0 -0.5 Japan Germany ∆ ≡ ∆ ∆ ×∆ ΔLabor productivity ΔLabor input Sources: HAVER; Cabinet Office; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Slide 7 Labor Input 2006-2016 avg., y/y % chg. 2.0 Hours worked per person employed Unemployment rate 1.5 Labourforce forceparticipation participationrate rate Labor Population Labourinput input Labor 1.0 0.6 0.5 0.0 -0.3 -0.5 -1.0 Japan ∆ ∆ ≡ ∆ × Germany ∆ ΔHours worked per person employed ∆ ∆ ΔUnemployment rate × ∆ ×∆ ΔLabor force participation rate Sources: HAVER; Cabinet Office; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Slide 8 Total Population and Working Age Population Germany Japan avg., y/y % chg. 2.5 2.5 Total population 2.0 1.0 1.0 Forecast 0.5 0.0 0.0 -0.5 -0.5 -1.0 -1.0 -1.5 -1.5 Working age population 1.5 0.5 -2.0 Total population 2.0 Working age population 1.5 avg., y/y % chg. -2.0 Forecast Sources: Eurostat; United Nations; Ministry of Health, Labour and Welfare. Slide 9 Foreign Workers mil. persons Germany Japan Sources: Eurostat; United Nations; Ministry of Health, Labour and Welfare. Slide 10 Labor Force Participation Rates Japan % In 2016 Male Female 15- 20- 25- 30- 35- 40- 45- 50- 55- 60- 6519 24 29 34 39 44 49 54 59 64 age group 100 % Male Japan Germany United States United Kingdom Sweden Female 15- 20- 25- 30- 35- 40- 45- 50- 55- 60- 6519 24 29 34 39 44 49 54 59 64 age group Sources: Ministry of Internal Affairs and Communications; OECD. Slide 11 International Comparisons of Labor Productivity Productivity Growth Rate Productivity Level US=100 1.6 avg., y/y % chg. 1.4 1.2 1.0 0.8 0.6 0.4 0.2 Japan Canada UK Italy US France Germany 0.0 Japan Canada UK Italy Notes: 1.The left panel shows the nominal GDP per hour worked as of 2015. 2.The right panel shows the average year-on-year rates of change in the real GDP per hour worked from 2000 to 2015. Source: UK Office for National Statistics. US France Germany Slide 12 Policy Interest Rates in Major Economies % Japan United States Euro area United Kingdom -1 CY 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 17 18 Note: For Japan, for the period when no target interest rate was adopted, figures for the policy rate are the interest rate applied on excess reserves. Sources: Bank of Japan; Federal Reserve; European Central Bank; Bank of England; Bloomberg; Haver. QQE with Yield Curve Control Slide 13 BOJ facilitates 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. 1.4 % 1.2 JGB yield curve 1.0 0.8 0.6 0.4 Short-term policy interest rate "minus 0.1 percent" 0.2 0.0 Target level of the long-term interest rate "around zero percent" -0.2 -0.4 0 1 2 3 4 5 6 7 8 9 10 year Source: Bloomberg. residual maturity Slide 14 Conduct of Yield Curve Control 10-year Government Bond Yields in Major Economies Yield Curves in Major Economies 3.5 % 3.0 % United States 3.0 2.5 United States 2.5 Germany Germany Japan Japan 2.0 2.0 1.5 1.5 1.0 1.0 US presidential election (November 8th) 0.5 0.5 0.0 0.0 -0.5 -1.0 1 year 2 -0.5 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Source: Bloomberg. Slide 15 Outlook for Economic Activity and Prices (October 2017) y/y % chg. Real GDP Fiscal 2017 Forecasts made in July 2017 Fiscal 2018 Forecasts made in July 2017 Fiscal 2019 Forecasts made in July 2017 CPI (all items less fresh food) ＋1.9 ＋0.8 ＋1.8 ＋1.1 ＋1.4 ＋1.4 ＋1.4 ＋1.5 ＋0.7 ＋1.8 ＋0.7 ＋1.8 Note: Figures indicate the median of the Policy Board members' forecasts (point estimates). Figures for the CPI (all items less fresh food) exclude the effects of the consumption tax hikes. Source: Bank of Japan. Slide 16 Corporate Profits and Labor Market Conditions Corporate Profits Job Openingsto-applicants Ratio Unemployment Rate s.a., % s.a., % 2.4 Ratio of current profits to sales (all industries and enterprises) s.a., ratio New job openings-toapplicants ratio 2.2 2.0 Active Job Openingsto-Applicants Ratio 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 0.2 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 Note: Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Sources: Ministry of Finance; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Slide 17 Real Wage Gap Real Wages and Labor Productivity 1980/Q1-2017/Q2 avg. =100 Real wages Real Wage Gap % Labor productivity -5 CY 85 -10 CY 85 Notes: 1. Real wages = personnel expenses / number of employees / GDP deflator. 2. Labor productivity = (operating profits + personnel expenses + depreciation expenses) / number of employees / GDP deflator. The data used to compute labor productivity except for the GDP deflator series are based on the “Financial Statements Statistics of Corporations by Industry, Quarterly,” and do not cover the finance and insurance industry. 3. The real wage gap is defined as the deviation of real wages from labor productivity. 4. Shaded areas indicate recession periods. 5. Data for real wages and labor productivity are seasonally adjusted. Sources: Cabinet Office; Ministry of Finance.
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Concluding remarks by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the IMF-JFSA-BOJ Conference on FinTech, Tokyo, 16 April 2018.
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April 16, 2018 Bank of Japan Central Banking in the Digital Age Closing Remarks at the IMF-JFSA-BOJ Conference on FinTech Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction I would like to express my sincere gratitude to all the participants. It was a great pleasure for us, the International Monetary Fund, the Financial Services Agency, and the Bank of Japan, to hold such a large conference on financial innovation in Asia. Indeed, this conference symbolizes how the world has changed in this decade. IT innovation and Changes in Finance and Economy Looking back on 2008, a decade ago, the biggest challenge to the IMF and financial authorities all over the world was how to tackle the global financial crisis. Smartphones were still in their very early stage. Crypto-currencies had not yet appeared. Since then the world economic landscape has dramatically changed. The global economy has overcome the crisis and regained its growth momentum. With the rapid innovation of information technologies, the movement described as the "information revolution" or "data revolution" has developed globally, bringing new growth opportunities for financial services and economic activities. Asia has been particularly influenced by such IT innovation. Let me pick up the issue of "financial inclusion" for example. This was a global social issue already as early as 2008. Since then the number of smartphones has skyrocketed, and many people, including those in emerging economies in Asia, have become able to access financial services via smartphones. IT innovation has promoted "financial inclusion" in a way which was not expected a decade ago. Such wider access to financial services is also stimulating various new economic activities. Smartphones also produce a gigantic amount of data as people use smartphones everywhere in their daily lives. Such "big data" are becoming more and more important as intangible assets in a broad range of economic activities. Global "data-giant" companies, which have grown rapidly in recent years, often provide various services including financial ones free of charge, while utilizing big data gathered through these services for multiple purposes. Moreover, IT innovation has created new business models, such as "the sharing economy." New policy challenges IT innovation also raises various new challenges to financial authorities, including central banks. Among them, let me point out four issues. (i) Impacts on Financial Markets First, high-frequency trading, or HFT, utilizing algorithms and AI has recently increased its role in various financial markets. Financial authorities need to carefully examine how such trading strategies influence price formation, market volatility and liquidity, since they may have important implications in terms of market stability and the transmission mechanisms of monetary policy. Also in this context, the new role of central banks as "market makers of last resort" moves into the spotlight. (ii) Impacts on Real Economy and Prices Second, we should try to understand the impacts of IT innovation as well as IT-oriented new business activities, such as e-commerce and the sharing economy, on the real economy and price developments. Such issues are deep-rooted and wide-ranging, and not limited to the issue of statistics, such as the difficulty in measuring the growth of e-commerce and the overall retail sales due to the limited coverage of existing statistics. Let me raise one of the fundamental challenges. Nowadays data-giant companies provide various free services because they use these services also for collecting data and utilize those data for their business. From the users' viewpoint, they actually give their own data to those companies in exchange for using these services, instead of paying fees. It is becoming more and more difficult to grasp such new economic activities by traditional analytical tools, such as demand and supply curves on price-quantity dimension. (iii) Importance of Cyber Security and Data Protection Third, in accordance with IT innovation, cyber-security and data-protection are becoming more important for maintaining financial stability. Recently, data-giant companies have entered into financial services, and the utilization of big data has become more pronounced in financial businesses. In addition, various new instruments, including the internet and smartphones, are used for access to financial services. All of these developments emphasize the importance of cyber-security and data-protection. (iv) Impacts on Currency, Payments and Settlements Lastly, we should carefully examine the impacts of IT innovation on currency, payments and settlements. "Crypto-currencies" and "central bank digital currencies" are now gathering great attention all over the world. Moreover, these issues also stimulate global discussions on to what extent central banks should provide their payment and settlement infrastructures to society. I would like to elaborate on these issues further. Innovation and Currency System Looking back in history, many central banks, including the Bank of Japan, were established to overcome the turmoil caused by the issuance of multiple payment instruments in a disorderly manner, so as to restore stability of the monetary system. In order to fulfill such a mission, central banks were exclusively assigned the role of issuing "central bank money" with finality, namely, banknotes and central bank deposits. The modern currency system, which consists of a central bank and private banks, is characterized as "a two-tiered system." In this two-tiered system, the central bank specializes in supplying banknotes and central bank deposits, while private banks perform the function of credit creation and provide deposit currencies as broader money. Through such activities, private banks provide payment services to the general public and allocate financial resources to the economy as loans and credits. From the perspective of information processing, the emergence of central banks allowed people to get rid of the burden of evaluating the credibility of many payment instruments. The creation of central banks has substantially reduced the costs of information processing in payments and settlements. At the same time, private banks have contributed to efficient allocation of financial resources through their function of information processing. The modern two-tiered structure reflects the wisdom of human beings in history to achieve both efficiency and stability in the currency system. In this regard, the issuance of central bank digital currencies for general use could be analogous to allowing households and firms to directly have accounts in the central bank. This may have a large impact on the aforementioned two-tiered currency system and private banks' financial intermediation. Under the current system, the central bank allows direct access to its accounts only to a limited number of entities such as private banks. From the viewpoint of the usage of information, the central bank leaves the private sector the opportunities to utilize detailed data such as "who buys what" attached to daily transactions. At the same time, the central bank can obtain the information necessary to maintain the stability of payment and settlement systems through operating its wholesale settlement systems. The issuance of central bank digital currencies could also affect such a role-sharing structure for utilizing information. To sum up, IT innovation raises many fundamental questions and challenges related to the currency system, the design of central bank infrastructure and the utilization of information attached to economic activities. I sincerely hope our understanding of these issues will be further deepened in the future. Initiatives Taken by the Bank of Japan To tackle these new challenges, the Bank of Japan has recently been taking various initiatives in the fields of innovation and FinTech. In 2016 the Bank established its "FinTech Center." The Bank has also been conducting a joint research project called "Project Stella" with the European Central Bank to study the potential of distributed ledger technology. Although the Bank of Japan does not have a plan to issue its own digital currency at this juncture, the Bank fully acknowledges the importance of deeply understanding innovative technologies not only for maintaining financial stability but also for seeking the possibility of applying them to central bank infrastructure in the future. Central banks should always be attentive to on-going innovation, and continue making efforts to provide the best infrastructure to society in accordance with the development of technologies. I believe that this conference was very informative and fruitful for all participants. I sincerely hope that discussions on these issues will continue in various international forums, in order for innovations to contribute to the development of financial services and economic activities. At the end of my remarks, I wish each of you a safe journey home. Thank you for your attention.
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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, Gunma, 24 May 2018.
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May 24, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Gunma 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 with developments in overseas economies. Overseas economies have continued to grow firmly on the whole. Trade activity was sluggish globally following the financial crisis of 2008, but it has been recovering markedly recently. Under these circumstances, as favorable effects spill over from advanced to emerging economies, the momentum toward recovery is spreading to broader regions. Global financial markets, which became somewhat unstable from February, have been regaining calmness of late. Looking at developments in detail, the U.S. economy has been expanding. As exports have been on an increasing trend, business and household sentiment is improving as well. Expansionary fiscal measures taken by the U.S. government are also expected to push domestic demand upward in the short term. The European economy also has continued to recover firmly as a trend. Although several economic indicators have showed signs of a slowdown recently, this is considered to be due to temporary factors such as a reaction to the high growth that continued until the end of 2017, unfavorable weather conditions, and industrial strikes. Among emerging economies, the Chinese economy has continued to see stable growth on the whole. Exports have been increasing, and domestic demand has continued to be firm, underpinned by growth in public investment. In the NIEs and the ASEAN countries, exports have been following an uptrend, and domestic demand has been resilient on the back of the improvement in business and household sentiment and economic stimulus measures taken by their authorities. Commodity-exporting economies such as Brazil, Russia, and South Africa have been recovering moderately as their central banks have been engaging in monetary easing following the declines in their inflation rates. Since February 2018, global financial markets, mainly in the United States, have exhibited unstable movements. However, this is considered to represent a strong reaction to the steep stock price rise from the latter half of 2017, which was partly caused by expectations for fiscal expansion in the United States, and to the overheated speculative trading in some countries of financial products, betting on a decline in financial market volatility. Recently, as these developments have subsided, global financial markets seem to be regaining calmness. As for the outlook, overseas economies are expected to continue growing firmly. As trade activity in the manufacturing sector has stayed firm globally, advanced and emerging economies are expected to grow in a well-balanced manner. According to the April 2018 World Economic Outlook (WEO) released by the International Monetary Fund (IMF), the global growth rate was projected at 3.9 percent in each of 2018 and 2019, up slightly from 3.8 percent in 2017. B. Recent Developments in Japan's Economy Next, I will discuss developments in Japan's economy. Japan's economy is expanding moderately, with steady growth in overseas economies as well as highly accommodative financial conditions and government spending. A virtuous cycle operating from income to spending has become stronger in both the corporate and household sectors, and the economy is in the process of shifting from growth led by external demand to more self-sustaining growth accompanied by a recovery in domestic demand. The economy recorded positive growth for the eighth consecutive quarter until the end of 2017. Although it marked small negative growth in the January-March quarter of 2018, this was due to temporary factors such as unfavorable weather conditions. As relatively high economic growth has continued as a trend, the positive output gap -- an indicator of the utilization of capital and labor -- has been widening steadily. Amid the growing supply-side constraints in some sectors of the economy, firms are taking measures to enhance supply capacity, such as increasing their labor force, making business fixed investment that is intended to promote labor saving and expand production capacity, and streamlining their business processes. As a result, Japan's economy has maintained well-balanced growth on both the demand and supply sides. Looking at developments in more detail, in the corporate sector, exports have been on an increasing trend on the back of the firm growth in overseas economies. For example, here in Gunma Prefecture, exports, particularly of transportation machinery, showed strength. A factor contributing to the strength in overall exports is the growth in inbound demand led by the increasing number of visitors to the World Heritage site Tomioka Silk Mill and to popular hot springs. As Japan's economy has continued to grow moderately, corporate profits and business sentiment also have maintained their improving trend. While labor shortages have continued and supply-side constraints gradually have become apparent, as evidenced by delays in procurement of some components in the manufacturing sector and an increase in front-loaded orders placed in anticipation of future delays, firms are becoming more active in making business fixed investment intended to promote labor saving and expand production capacity. According to the Bank's March 2018 Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion index for business conditions for all industries and enterprises improved for the seventh consecutive quarter, reaching the highest level since 1991. 1 Business fixed investment plans for all industries and enterprises, including financial institutions, showed a relatively strong year-on-year increase of 4.3 percent for fiscal 2017 and 2.0 percent for fiscal 2018. Let us turn to the household sector. Labor market conditions have tightened steadily as the number of employees has increased. The active job openings-to-applicants ratio has surpassed the peak level observed during the bubble period. The unemployment rate is 2.5 percent, a level that essentially represents a situation close to full employment. Firms are making active efforts to secure their labor force while expanding the scope of workers who may be employed and are promoting a shift from non-regular to regular employment. Wages of part-time employees, which are responsive to labor market conditions, have risen markedly. Although wages of regular employees -- the majority of employees -- have continued to increase only moderately, there are signs of gradual yet stronger improvement in wages. For example, the growth in base pay in fiscal 2018 is projected to exceed the actual growth of a year earlier, as in the previous year, and the share of firms raising wages The diffusion index for business conditions is calculated as the proportion of firms responding that business conditions were "favorable" minus the proportion of those responding that they were "unfavorable." of regular employees is growing. With the employment and income situation improving, as I have mentioned, private consumption also has been increasing moderately. C. Outlook for Japan's Economy As for the outlook, Japan's economy is likely to continue its moderate expansion, supported by the highly accommodative financial conditions and stimulative fiscal measures. In line with the firm growth in overseas economies, exports are likely to maintain their increasing trend. As a virtuous cycle operating from income to spending is being maintained in both the corporate and household sectors, business fixed investment and private consumption are also likely to follow an uptrend. I believe that the impact of the consumption tax hike scheduled for 2019 is highly uncertain, yet most likely to be smaller than the impact of the tax hike in 2014. At the time of the previous consumption tax hike, the last-minute rise in demand before the hike and the ensuing fallback in demand turned out to be strong, particularly with respect to high-priced products, not only because the margin of the hike was large but also because a second tax hike was expected down the road. Application of a reduced tax rate on some products and policies concerning the provision of free education will also contribute to lightening the burden on households. According to the April 2018 Outlook for Economic Activity and Prices (hereafter the Outlook Report) released by the Bank, the median of the Policy Board members' forecasts of the real GDP growth rate in fiscal 2018 was 1.6 percent. This represents a slight upward revision of the forecast made three months ago. In fiscal 2019 and 2020, the growth rate is expected to decline to around 0.8 percent, a level close to the potential growth rate, because of such factors as a cyclical slowdown in business fixed investment and a fallback in Olympic Games-related demand. Needless to say, the outlook is not free from uncertainty. Among the main risks, we must keep a watchful eye on overseas factors. In particular, I am concerned about a possible spread of protectionist measures in trade policy. In the past, trade and investment liberalization, coupled with the advances in technological innovation, has driven global economic growth. As new technologies have been disseminated through trade and investment activities, productivity improvement and further technological development have been promoted across the regions. If the protectionist mood gains traction and constrains trade and investment, the global economy could be deprived of its main growth engine. Moreover, uncertainty over the U.S. economic policy management is growing. If the inflation rate accelerates or concerns over the deterioration of the fiscal balance grow while favorable economic conditions continue and the government implements expansionary fiscal measures, there is a risk that interest rates will shoot up, triggering a stock price plunge and changes in the global flow of funds. In addition, we must keep a watchful eye on the negotiations on the United Kingdom's exit from the European Union (EU) and geopolitical risks related to North Korea and the Middle East. All these risk factors could significantly affect Japan; therefore, while continuing to pay due attention to them, the Bank will closely examine developments at home and abroad. II. Prices A. Current Situation Next, I will turn to price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food for April, which was released on May 18, 2018, was 0.7 percent. The rise in energy prices has contributed considerably to the increase in the CPI. Meanwhile, the increase in the CPI for all items less fresh food and energy for April remained only moderate, with the year-on-year rate of change standing at 0.4 percent. Despite the continued improvement in economic conditions, the growth in wages and prices has been sluggish, and various factors have been pointed out as the causes. I am paying particular attention to the changes in the economy's supply capacity. For example, while the tightness in labor market conditions has been highlighted by the media, the labor force participation rate, which had been trending downward, has started to rise, partly as a result of various initiatives conducted by the government and firms. In addition, the number of employees who have reluctantly accepted non-regular employment -- due to a lack of opportunities to work as regular employees -- is declining. This is because firms are promoting a shift from non-regular to regular employment in order to retain their labor force. Firms also have made progress with such activities as making business fixed investment intended to promote labor saving and streamlining their business processes. 2 All of these changes lead to an expansion of the economy's supply capacity in terms of labor input and labor productivity. I believe that such expansion appears to be easing the upward pressure on wages and prices associated with an increase in demand. B. Outlook That being said, I do not believe that the sluggish growth in wages and prices will continue forever. There are certain limits to the extent of such activities as raising the labor force participation rate, promoting a shift from non-regular to regular employment, and streamlining business processes. In the longer term, the effects of the expansion of supply capacity in curbing growth in wages and prices are expected to decline in due course. Meanwhile, the expansion of the economy's supply capacity will strengthen the economy's growth potential. If expectations for growth increase on the back of the continued expansion of supply capacity, thereby increasing expectations of households regarding permanent income and of firms about future earnings, this may push up wages and prices through active consumption and business fixed investment. As I explained so far, although the recent expansion of the economy's supply capacity may delay growth in wages and prices in the short term, it is unlikely to become a factor that will keep wages and prices at low levels in the long term. As wages and prices start increasing, the public's inflation expectations are likely to rise through the adaptive formation mechanism. Therefore, my judgment is that the momentum toward achieving the Bank's 2 percent price stability target is being maintained. According to the April 2018 Outlook Report, the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI for all items less fresh food were 1.3 percent for fiscal 2018 and 1.8 percent for fiscal 2019 and 2020, excluding the effects of the consumption tax hike. The annex to the Regional Economic Report (available only in Japanese) released in December 2017 presents some cases of firms' initiatives taken toward improving productivity. III. Monetary Policy A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control In September 2016, the Bank introduced QQE with Yield Curve Control as a new framework for strengthening monetary easing. This framework consists of two main components. One of the two is yield curve control, whereby the Bank facilitates the formation of shortand long-term interest rates that are considered most appropriate in light of the 2 percent price stability target. In the Bank's current guideline for market operations, the short-term policy interest rate is set at minus 0.1 percent and the target level for yields on 10-year Japanese government bonds (JGBs) is set at around 0 percent. This is intended to support proactive economic activities by Japanese firms and households through maintaining highly accommodative financial conditions. The other main component is the inflation-overshooting commitment. This represents the Bank's strong commitment to continuing to expand the monetary base until the observed year-on-year rate of increase in the 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 Japan, the inflation rate has remained stable at low levels over a long period of time. For Japanese firms and households, the low inflation rate has become a quite natural condition that serves as a premise for conducting economic activities. Going forward, in order to raise prices in a stable manner, it is necessary to encourage firms and households to change their behavior patterns by making them actually experience an inflation rate higher than 2 percent. B. Future Conduct of Monetary Policy In light of the recent relative weakness of prices, I believe that it is appropriate for the Bank, for the time being, to maintain the accommodative financial conditions with persistence under the current policy framework. While doing so, the Bank needs to keep in mind the following two factors. First, it is necessary to keep a careful watch on preventing a significant supply-demand imbalance. As I mentioned earlier, the pace of the expansion of the economy's supply capacity eventually may slow in the longer term. Meanwhile, yield curve control contains a mechanism of amplifying its own easing effect as inflation expectations rise and the economy's growth potential increases. In this respect, it is possible that changes in the supply-demand balance will occur in line with the slowdown in the pace of expansion of the supply capacity and the strengthening of the effects of demand-stimulating measures taken on the monetary front. If a significant deterioration in the supply-demand balance is left unattended for a long time, this may unnecessarily cause sharp economic swings. I will discuss this point later in more detail. Second, it is necessary to pay due attention to not making the financial system unstable by maintaining accommodative financial conditions over a long period of time. According to the Bank's assessment presented in the April 2018 Financial System Report, although Japan's financial system as a whole is not showing any sign of overheating, some indicators, such as the lending attitudes of financial institutions, are very close to a state of overheating. Furthermore, if the low interest rate environment continues and downward pressure on financial institutions' profits becomes prolonged, the functioning of financial intermediation may be undermined. I believe that the Bank will need to review these points at each Monetary Policy Meeting and, as necessary, consider in earnest the most appropriate monetary policy. IV. Changes in the Economy's Supply Capacity and Conduct of Monetary Policy So far, I have mentioned several factors associated with the expansion of the economy's supply capacity as the causes of the delay in growth in wages and prices. From now, although there will be a degree of overlap with some of the points I have touched upon earlier, I will discuss somewhat longer-term changes in the supply capacity of Japan's economy and how monetary policy should be conducted in response to the changes. A. Changes in the Economy's Supply Capacity In Japan, various changes have taken place in the economy's supply capacity since the 1990s due to deficient demand and deflation that have lasted for a protracted period. Based on the experience of struggling to overcome excessive employment, firms tightened their employment stance and promoted a shift to non-regular employment. Consequently, an increasing number of people gave up on seeking jobs or reluctantly accepted non-regular employment as they could not obtain their ideal jobs. In addition, because firms reined in new business fixed investment in order to reduce excess production capacity, their capital stock became obsolete and new technologies were not necessarily introduced actively. Moreover, excessive competition among firms to provide extravagant services or excessively cut the prices of their services or products was seen everywhere, and this may have led in part to the decline in labor productivity. The mechanism by which an economic downturn, which fundamentally is a cyclical phenomenon, exerts downward pressure on the economy's long-term growth potential by affecting the supply capacity is called "hysteresis." In Japan, the hysteresis has indeed occurred under the successive and serious economic downturns. On the other hand, recently, the economy's supply capacity appears to be expanding rapidly with the waning effects of hysteresis that occurred in the past. For example, there are increasing opportunities for those who potentially have the willingness to work to participate in the labor market and for those who have reluctantly accepted non-regular employment to obtain regular employment. Firms are also starting to undertake postponed business fixed investment, and are proceeding with efforts to streamline their business processes through suspending the provision of extravagant services and reassigning employees to new positions. As labor input has increased and labor productivity has risen through these changes, the long-term growth potential of Japan's economy, which declined substantially in the past, is gradually strengthening again. Currently, Japan's economy may be referred to as being in a rehabilitation process to regain its fundamental strength. The effects of hysteresis have been pointed out in overseas economies as well. These effects have attracted increased attention, especially as the economic growth trend has shifted downward globally since the financial crisis in the latter half of the 2000s. Since the early 1990s, however, the growth trend in Japan's economy has marked falls ahead of those in other economies following each successive and serious economic downturn. In this respect, there is a possibility that the effects of hysteresis remain relatively strong in Japan. For example, Japan's low labor productivity is well known as being lower than that of other advanced economies. If we take a look at this situation from another perspective, it can be said that there is ample room for Japan to expand its economy's supply capacity as the effects of hysteresis dissipate. Indeed, Japan's labor productivity recently has been improving at a relatively fast pace to catch up with other economies. The expansion of the economy's supply capacity, in the short term, has been working in the direction of easing the upward pressure on wages and prices associated with an increase in demand. However, there is no need to be unduly pessimistic about the current situation. As I mentioned earlier, the momentum toward achieving the price stability target is being maintained. In addition, we should not focus solely on raising prices. It is desirable that prices rise moderately as the quality of people's lives improves. Recently, an increasing number of people are participating in the labor market in ways that meet their wishes, and firms are promoting a shift to more efficient and adequate work practices. As a result, the economy's long-term growth potential is also beginning to be raised. I believe that these changes will indeed enrich people's lives. B. Framework of Monetary Policy Based on what I have presented, I would now like to reconsider the framework of monetary policy. My view is that monetary policy should aim at maintaining somewhat tight supply-demand conditions, which are currently in place, for as long as possible. As I have explained, I believe that Japan's economy at present, except for sluggish inflation, is in a very favorable condition. Driven by an increase in demand, various benefits stemming from the expansion of the supply capacity have been brought about. It is possible that these benefits are relatively large as the adverse effects of hysteresis that occurred in the past have remained strong in Japan. Of course, this does not mean that a rise in prices is unwelcome. The Bank should achieve the price stability target at the earliest possible time. Note, however, that we should not misunderstand the meaning of "at the earliest possible time." This does not mean that the Bank should try to achieve the target at whatever cost. Its mission, as stipulated in the Bank of Japan Act, is "achieving price stability, thereby contributing to the sound development of the national economy." If sound development of the economy is hindered as a consequence of a rise in prices, this will confuse the essential with the unessential. For example, because of the relatively slow pace of change in the supply capacity, if the pace of increase in demand accelerates, prices might rise significantly due to increased supply-side constraints. However, if economic swings amplify in this way, there is concern that various harmful effects, such as a decline in the efficiency of resource allocation, might arise. The Bank will then be rushed into tightening its monetary policy, possibly resulting in the reversal of hysteresis left undone. Most of all, price rises attained in this way will not be stable over the long term, and nobody will want such a circumstance. With the understanding just described, it is essential to aim at achieving the price stability target while benefiting from the waning effects of hysteresis brought about by maintaining somewhat tight supply-demand conditions. I should add that there is no universal monetary policy measure that should be taken to this end. As I mentioned earlier, from a somewhat longer-term perspective, the room for expanding the economy's supply capacity will narrow in due course as the effects of hysteresis dissipate further. On the other hand, if inflation expectations rise or the economy's long-term growth potential increases, the demand-stimulating effects of yield curve control will strengthen. On this point, when conducting monetary policy in the future, I believe that the Bank, as necessary, should consider without prejudgment the most appropriate policy while paying close attention to preventing a significant supply-demand imbalance that might be caused by the described changes in the external environment. C. Uncertainty and Communication Lastly, I would like to point out that there is a certain degree of uncertainty over how the economy's supply capacity will change in the future. There are various arguments concerning the extent to which the adverse effects of past hysteresis can be reversed; apparently, no consensus has been reached in academic or other circles. Moreover, as a matter of course, changes in the supply capacity of Japan's economy are attributable not only to hysteresis but also to more structural factors, such as demographics. Therefore, it is difficult to accurately make a forecast on the extent to which the expansion of the supply capacity of the economy will be maintained and how long this expansion will constrain price rises. In relation to this, the fact that the Bank deleted the description on the projected timing of reaching around 2 percent inflation in the April 2018 Outlook Report became an issue for the public. I believe that indicating the projected timing itself is meaningful, but this "projection" tended to be perceived by some market participants as a "deadline," thereby creating unnecessary speculation about the Bank's policy conduct. As I have explained, monetary policy should be conducted by taking into consideration various uncertainties, and therefore it is undesirable to attract excessive attention merely to specific timing or a numerical value. Based on these points, I have judged that deleting the description of the projection in the Outlook Report is unavoidable. I believe that providing a detailed and articulate explanation on the mechanism of price rises and on the assessment of risks will lead to more appropriate communication with market participants. Today, I have expressed my views on changes in the supply capacity of Japan's economy and how monetary policy should be conducted in response to these changes. The Bank will persistently pursue monetary easing measures and provide its utmost support for the sound development of the national economy by ensuring price stability. Under such circumstances, I hope to see continued proactive initiatives and efforts by firms and the government.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 10 May 2018.
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May 10, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at the Kisaragi-kai Meeting in Tokyo 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 speak at the Kisaragi-kai meeting. Five years have passed since the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013, and Japan's economy -- which had been deteriorating under prolonged deflation -- has improved significantly. Recently, corporate profits have been at record high levels, and the labor market is close to full employment. Although the price stability target of 2 percent has not been achieved yet, Japan's economy is at least no longer in deflation, which is generally defined as a sustained decline in prices, after having overcome negative shocks such as the large drop in crude oil prices. Over the past year, the year-on-year rate of change in the consumer price index (CPI) has increased moderately, registering around 1 percent of late. Today, I will first explain in detail the current situation of economic activity in Japan and its outlook, while outlining the Outlook for Economic Activity and Prices (Outlook Report) released after the Monetary Policy Meeting (MPM) held at the end of April. Then, I would like to talk about the Bank's thinking behind the conduct of monetary policy. I. The Current Situation of Economic Activity and Its Outlook Overseas Economies Let me start by talking about economic developments. I will first touch on developments in overseas economies. Overseas economies have continued to grow firmly. The last time I gave a speech at the Kisaragi-kai meeting last December, I referred to the remark by Christine Lagarde, the Managing Director of the International Monetary Fund (IMF), that the global economy is showing "the broadest-based recovery in the last 10 years." In the almost half year since then, this synchronous growth of the global economy, with both the advanced and emerging economies growing in a well-balanced manner, has become more pronounced. Such synchronous growth can also be observed at the industry level (Chart 1). While the global economy had continued to recover moderately over the past few years, led mainly by the nonmanufacturing sector, since around last year, production and trade activity in the manufacturing sector have picked up substantially, reflecting an expansion in IT-related demand due to the use of artificial intelligence (AI) and the Internet of Things (IoT), as well as growing demand for capital goods due to a rise in capital utilization rates on a global basis. Given such positive cycle operating in a wide range of regions and industries, it is highly likely that overseas economies will continue to grow firmly for the time being. In the IMF's quarterly projections for global economic growth based on its World Economic Outlook (WEO), those for 2018 and 2019 were revised upward markedly in April 2018 from the October 2017 projections, with growth expected to register 3.9 percent, exceeding the long-term average since the 1990s. There is, of course, considerable uncertainty as to how long such high economic growth will last. Among advanced economies, the U.S. economy in particular has continued its long recovery phase for nine years already, and the growth pace is projected to decelerate somewhat around 2020. In this context, some have expressed concerns that the U.S. economy might experience a significant downturn, but I consider this risk to be small. The reason is that, in the early phase of the current recovery in the early 2010s, the level of economic activity was low and the growth pace remained very moderate. Therefore, although the economy has been recovering for a long time, there seem to be no signs of overheating, such as an excess build-up of capital and housing stock. Meanwhile, the recovery in emerging economies is likely to take a firmer hold, given that growth rates in commodity-exporting economies -- which had been lagging behind due to the effects of sluggish commodity prices -- have been gradually increasing. Thus, overseas economies are expected to grow firmly, with growth momentum shifting from advanced to emerging economies. Current Situation of Japan's Economic Activity Next, I will talk about Japan's economy. The economy has been expanding steadily, albeit at a moderate pace, supported in part by the growth in overseas economies that I just mentioned. The output gap, which represents the utilization of capital and labor, exceeded the long-term average of 0 percent in the second half of 2016, and since then has continued to widen further in positive territory (Chart 2). The diffusion index (DI) for business conditions for all industries and enterprises in the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan) -- which is an indicator of firms' business sentiment -- suggests that business conditions have improved for seven consecutive quarters, reaching the highest level since the early 1990s. Looking in more detail, in the corporate sector, exports and production have been on an increasing trend (Chart 3). As I mentioned earlier, demand for IT-related and capital goods has been expanding on a global basis, and this has acted as a tailwind for Japan's manufacturing sector, which has a comparative advantage in these goods. In fact, Japan's real exports marked a new record high in November 2017 for the first time in about 10 years, exceeding the peak before the global financial crisis, and have maintained their uptrend. In this situation, corporate profits have been at record high levels, and business fixed investment has continued on an increasing trend. According to the Tankan, business fixed investment plans for fiscal 2018 as of March have turned out to be favorable for this time of the year, significantly exceeding the average of the past. There also has been improvement in the household sector. While labor market conditions have been tightening further, with the unemployment rate declining to about 2.5 percent for the first time since 1993, employee income has continued to increase moderately (Chart 4). Private consumption has been increasing moderately, albeit with fluctuations, against the background of this steady improvement in the employment and income situation. Outlook for Japan's Economic Activity Now I will turn to the outlook for Japan's economy. In the latest Outlook Report released at the end of April, the Bank presents its projections for Japan's economic activity through fiscal 2020. In terms of the medians of the Policy Board members' forecasts, the real GDP growth rate is projected to register relatively high growth of 1.6 percent in fiscal 2018 and continue to mark positive growth of 0.8 percent in fiscal 2019 and fiscal 2020 (Chart 5). In fiscal 2018, the mechanism supporting the current favorable economic conditions is expected to continue operating. Domestic demand is likely to follow an uptrend, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending. Exports are expected to continue their moderate increasing trend on the back of the firm growth in overseas economies. Under these circumstances, in fiscal 2018, the economy is likely to continue growing at a pace above the potential growth rate, which is currently estimated to be in the range of 0.5-1.0 percent. From fiscal 2019 through fiscal 2020, Japan's economy is expected to continue on an expanding trend, although the growth pace is projected to decelerate somewhat. If the economy performs as projected, the duration of the current recovery phase, which started in December 2012, will be the longest in the post-war era, significantly exceeding the record of 73 months registered during the recovery period in the 2000s (Chart 6). The key issue underlying this outlook are the reasons why the long-lasting recovery is likely to continue. In what follows, I will outline three reasons. The first is that overseas economies are projected to continue growing firmly in a well-balanced manner in terms of regions and industries, as I explained earlier. Japan's exports are expected to follow an increasing trend supported by this tailwind and continue to firmly underpin the economy. The second reason is that, even though Japan's economic expansion is becoming quite long, it is likely that the pressure to adjust accumulated capital stock will not heighten as much. In the past, long-lasting economic expansion was accompanied by a capital stock cycle, in which capital stock gradually had built up and capacity utilization rates had declined, thereby suppressing new business fixed investment. It is expected that, during the current recovery phase, capital accumulation will continue to some extent in such areas as construction in the leadup to the Tokyo Olympic Games in 2020. However, in the manufacturing sector, there is a sense that capital stock is still insufficient, mainly due to the increase in exports, and it is likely that the expansion in global IT-related demand underlying this increase in exports will continue to last for a long time. In addition, due mainly to acute labor shortage, many firms in a wide range of industries are actively making labor-saving investment, and in view of the structural decline in the working-age population, these developments are expected to continue going forward. Furthermore, it can be expected that firms' growth expectations will gradually improve. If firms' growth expectations rise, they will revise upward the level of capital stock that they consider necessary for future production activities, creating new investment demand. With the economic and price situation continuing to improve, and coupled with the government's growth strategy, it is expected that firms' sentiment -- which had deteriorated under deflation -- will improve, stimulating investment demand. The third reason is that private consumption is likely to continue increasing moderately amid the improvement in the employment and income situation. In this context, the consumption tax hike scheduled for October 2019 may affect the economic growth rates going forward. However, the increase in the consumption tax rate is smaller than that of the previous tax hike in 2014, and measures such as a reduced tax rate and free education will be implemented. Therefore, the increase in the household burden as well as the negative impact on private consumption and the economic growth rates are expected to be smaller than after the last tax hike. Risks to Economic Activity There are, of course, upside and downside risks to this baseline scenario of the outlook for Japan's economic activity. One of the risk factors is the U.S. economic policies, especially the heightening uncertainties over its protectionist trade policy. As stated in the Group of Twenty (G-20) communiqué, "[i]nternational trade and investment are important engines of growth, productivity, innovation, job creation and development." Therefore, if protectionist moves were to spread globally, they could hamper trade activity, which finally has been recovering, and constrain global economic growth. As economies have become increasingly interdependent through global value chains, countries that adopt protectionist policies may face disadvantages in that such policies could impede necessary imports. Therefore, a brake is expected to be put on excessive protectionist moves at some point, but we will not be complacent and will closely monitor the situation. The effects of major economies' policies on global financial markets also warrant attention. For instance, global equity markets have been unstable since February this year, and it is said that this was triggered by a sharp increase in long-term interest rates reflecting the fact that U.S. wage growth exceeded market expectations, which gave rise to speculation that the pace of policy rate hikes by the Federal Reserve could accelerate. In addition, the uncertainties over U.S. trade policy that I mentioned earlier have been cited as another reason for the recent volatility in stock prices in various countries and foreign exchange rates. With the fundamentals of major economies remaining favorable, financial markets have been regaining some calmness, but markets sometimes move suddenly, triggered by minor matters. As volatility in financial markets may affect firms' and households' sentiment, we will pay constant attention to financial market developments. Turning to domestic risk factors, we need to bear in mind uncertainty regarding the effects of the scheduled consumption tax hike that I mentioned earlier, as well as both upside and downside risks to developments in firms' growth expectations. For example, firms may not abandon the cautious mindset that had become entrenched under deflation and easily embark on proactive investment activities. On the other hand, it is also possible that, amid rising growth expectations, there may be a major switch among firms to start using the high level of accumulated corporate savings for proactive investment. II. Current Situation of and Outlook for Prices Current Situation of and Outlook for Prices Next, I will move on to price developments in Japan. The year-on-year rate of change in the CPI excluding fresh food has increased to around 1 percent. The rise in energy prices partly contributed to this, and the rate of change in the CPI for March excluding fresh food and energy was 0.5 percent (Chart 7). The Bank has not changed its basic assessment that prices have continued to show relatively weak developments compared to the economic expansion and the labor market tightening. Nevertheless, the year-on-year rate of change in the CPI has been rising steadily for over a year, albeit at a moderate pace, and the momentum toward achieving the price stability target of 2 percent is firmly maintained. Going forward, the year-on-year rate of change in the CPI is likely to continue on an uptrend and increase toward 2 percent, mainly on the back of an improvement in the output gap and a rise in medium- to long-term inflation expectations. This baseline scenario is unchanged from the previous ones. The medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI excluding fresh food are 1.3 percent for fiscal 2018 and 1.8 percent for both fiscal 2019 and fiscal 2020 (Chart 8). The Inflation Mechanism I would now like to explain the mechanism through which inflation will rise toward 2 percent. The Bank conceptually divides this mechanism into two steps. First, the output gap improves in line with economic expansion, which will raise actual prices by making firms' wage- and price-setting stance more proactive. Second, as actual prices increase, firms' and households' medium- to long-term inflation expectations rise, which will further push up the actual inflation rate. As for the first step, the improvement in the output gap is steadily pushing up wages and prices. In terms of wages, those of not only part-time but also full-time employees are rising against the backdrop of tightening labor market conditions. According to various surveys, the rate of increase in base pay for fiscal 2018 has exceeded the actual rate for last year, and the proportion of firms that are increasing wages for full-time employees has also increased (Chart 9). Firms are also increasingly reflecting rising wage costs in their sales prices. In the March Tankan, the DI for output prices for small enterprises, following that for large enterprises, has turned positive for the first time in 27 years, since 1991 (Chart 10). Thus, the first step of the mechanism is working steadily. While it cannot be denied that the momentum of prices is not yet sufficiently firm compared to the economic expansion, the year-on-year rate of change in the CPI excluding fresh food and energy has continued to rise moderately since bottoming out in March 2017. Next is the second step of the mechanism: whether actual price increases have led to a rise in medium- to long-term inflation expectations. In this regard, recent trends indicate that inflation expectations have been more or less unchanged, although they have moved out of the weakening phase (Chart 11). Given these circumstances, going forward, it is important for the second step of the mechanism in particular to operate more clearly toward achieving the price stability target of 2 percent. To that end, it is necessary for the first step to continue operating amid the long-lasting recovery, so that actual price increases affect people's perception of prices and firmly push up inflation expectations through the adaptive formation mechanism. Going forward, if firms and households become increasingly confident that improvements in economic activity and prices are not temporary, the mindset and behavior based on the assumption that wages and prices will not increase will change and inflation expectations will rise firmly. The spread of base pay increases in the past few years can be regarded as an indication of such change. If people's deflationary mindset changes, the forces that let inflation expectations converge to the 2 percent target that the Bank is committed to achieving -- that is, the operation of the forward-looking formation mechanism -- will become much stronger. Risks to Prices Regarding the aforementioned baseline scenario of the outlook for prices, the Bank's assessment is that risks are skewed to the downside. For example, if there is strong uncertainty about future growth, firms will hesitate to raise wages in view of increasing employment to expand their business. In that case, the pace of increase in actual wages and prices -- that is, the operation of the first step of the inflation mechanism -- may be weaker than expected. Moreover, even if firms' wage- and price-setting stance becomes more proactive, inflation expectations may not rise smoothly; in other words, the second step of the mechanism may not operate fully. Past experience suggests that there is a certain time lag before actual inflation affects inflation expectations and the length of this lag is highly uncertain. So far, there has not been enough academic literature on the learning process through which firms and households revise their inflation expectations upward when faced with actual price rises. Taking into consideration that the experience of 15 years of deflation had become deeply entrenched in people's mindset and behavior, we need to keep in mind that it might take a fair amount of time before actual inflation starts to affect inflation expectations. Thus, in a situation where there are various risks and uncertainty is high, with a view to making an assessment of the outlook for prices and being accountable for this, it would not be proper -- and not represent adequate information dissemination by the Bank -- to attract excessive attention merely to forecast figures. As also highlighted by Federal Reserve Chairman Powell, it is difficult to make accurate forecasts about future economic developments, and too much emphasis should not be placed on the medians of board members' forecasts. Regarding the timing of the year-on-year rate of change in the CPI reaching around 2 percent, up until the previous January 2018 Outlook Report, the Bank provided specific descriptions such as that this would likely be around fiscal 2019; however, the latest report does not include such descriptions. The Bank believes that giving a detailed and articulate explanation on price developments based on a comprehensive assessment -including the mechanism through which the year-on-year rate of change in the CPI increases toward 2 percent and the assessment of risks -- leads to more appropriate communication to the public. III. The Conduct of Monetary Policy Let me now turn to the Bank's conduct of monetary policy. The Bank has been pursuing powerful monetary easing with a view to achieving the price stability target of 2 percent. Specifically, under the framework of "QQE with Yield Curve Control" introduced in September 2016, it facilitates the formation of the yield curve that is considered most appropriate for achieving the 2 percent target judged on the basis of developments in economic activity and prices as well as financial conditions. At the MPM held at the end of last month, the Bank maintained 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 the 10-year Japanese government bond (JGB) yields at around zero percent. The thinking behind this conduct of monetary policy is as follows. First of all, taking a look at developments in economic activity and prices, the economy has been improving steadily, but prices have not yet been sufficiently firm compared to the degree of improvement in the economy, as I mentioned earlier, and thus there is still a long way to go to achieve the price stability target of 2 percent. Downside risks to prices also warrant attention. Therefore, from the perspective of developments in economic activity and prices, it is necessary for the Bank to continue to pursue powerful monetary easing in line with the current guideline for market operations. Next, I would like to talk about the assessment of financial conditions. In the conduct of monetary policy, it is necessary to pay attention to both signs of overheating where financial imbalances build up and the stability of the financial system is impaired, as well as signs of a gradual pullback, in which financial institutions' profit environment deteriorates and their financial intermediation functioning declines. Regarding overheating, there is no sign so far of excessively bullish expectations in asset markets or in the activities of financial institutions. As for risks of a gradual pullback in financial intermediation, it has been pointed out that powerful monetary easing including negative interest rates affects financial institutions' profits and the functioning of financial intermediation, for example by reducing lending margins. Going forward, attention needs to be paid to the possibility that, if the low interest rate environment continues and downward pressure on financial institutions' profits becomes prolonged, this may have a cumulative effect on their financial strength and, as a result, the functioning of financial intermediation may be undermined. However, because Japanese financial institutions have sufficient capital bases, the Bank judges that there is no critical problem at this point in the functioning of financial intermediation due to a deterioration in profits. This is also evidenced by financial institutions' continued proactive lending attitudes (Chart 12). These examinations indicate that, at present, the yield curve that the Bank is currently aiming at is sufficiently effective in stimulating economic activity and prices while avoiding a negative impact on financial intermediation; in other words, the Bank judges the current yield curve to be the most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent. When examining developments in economic activity and prices as well as financial conditions under the framework of "QQE with Yield Curve Control," it is important to pay attention to the difference between real and nominal interest rates. When assessing the extent to which interest rates stimulate economic activity and prices, it is essential to consider the level of real interest rates, which is calculated by subtracting inflation expectations from nominal interest rates. Looking ahead, if real interest rates decline as inflation expectations rise, the stimulative effect on economic activity and prices will become stronger. In addition, as the potential growth rate of the economy rises with progress in implementation of the government's growth strategy and firms' continued efforts toward improving productivity, the natural rate of interest is projected to rise, and this is expected to enhance monetary easing effects. Going forward, the Bank will continue to pursue powerful monetary easing while taking advantage of this mechanism embedded in the framework of "QQE with Yield Curve Control" in order to achieve the price stability target of 2 percent at the earliest possible time. Lastly, I would like to make one more point. As mentioned earlier, the Bank has been conducting monetary policy while examining whether the momentum toward 2 percent inflation is being maintained, taking into account developments in economic activity and prices as well as financial conditions. The Bank has not set a specific deadline for achieving 2 percent inflation and does not conduct monetary policy with such a deadline in mind. The latest Outlook Report does not include a description on the projected timing of reaching around 2 percent inflation, and this partly aims to clarify this policy stance. Nevertheless, I would like to stress that this does not mean that the significance or nature of the price stability target has changed. Since the introduction of QQE in 2013, the Bank has committed itself to achieving the price stability target of 2 percent at the earliest possible time and continued to conduct large-scale monetary easing to underpin this commitment. Clearly demonstrating this determination is indispensable in changing the deflationary mindset that had become entrenched among people. The commitment to achieving 2 percent inflation at the earliest possible time has not changed. Conclusion Today, I have talked about Japan's economic and price developments and the Bank's conduct of monetary policy. Over the past five years, Japan's economic activity and prices have improved significantly, and are proceeding along a steady path toward achieving the price stability target of 2 percent. In that sense, QQE certainly has been producing its intended effects. On the other hand, it has become apparent that people's deflationary mindset is more deeply entrenched than expected, and that changing such mindset will take time. To make this happen, the current virtuous cycle of the economy -- in which the inflation rate gradually rises as corporate profits, employment, and wages increase -- needs to be maintained. With a view to achieving the price stability target of 2 percent, the Bank will continue to pursue powerful monetary easing with persistence and do its utmost to support such positive developments. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at the Kisaragi-kai Meeting in Tokyo May 10, 2018 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Global Economy IMF Projections of Real GDP Growth by Major Economies (as of April 2018) Global PMI s.a., DI y/y % chg. Manufacturing Services World 3.2 3.8 Advanced economies 1.7 2.3 United States 1.5 2.3 Euro area 1.8 2.3 Japan 0.9 1.7 4.4 4.8 China 6.7 6.9 ASEAN 5 5.0 5.3 Emerging market and developing economies CY10 [Projection] [Projection] 3.9 3.9 (＋0.2) (＋0.2) 2.5 2.2 (＋0.5) (＋0.4) 2.9 2.7 (＋0.6) (＋0.8) 2.4 2.0 (＋0.5) (＋0.3) 1.2 0.9 (＋0.5) (＋0.1) 4.9 5.1 (0.0) (＋0.1) 6.6 6.4 (＋0.1) (＋0.1) 5.3 5.4 (+0.1) (＋0.1) Notes: 1. Figures for the manufacturing PMI are the "J.P.Morgan Global Manufacturing PMI," and those for the services PMI are the business activity index of the "J.P.Morgan Global Services PMI." 2. Figures in parentheses in the right chart show the differences from the October 2017 projections (% points). Sources: IHS Markit (© and database right IHS Markit Ltd 2018. All rights reserved.); IMF. Chart 2 Japan's Economy Business Conditions DI (Tankan) Output Gap % DI ("favorable" - "unfavorable"), % points "Favorable" "Unfavorable" -10 -2 -20 -30 -4 -40 -6 -50 -8 CY90 92 94 96 98 00 02 04 06 08 10 12 14 16 17 -60 CY 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Notes: 1. Figures for the output gap are based on BOJ staff estimations. 2. Figures for the business conditions DI are those for all industries and enterprises. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: Bank of Japan. Chart 3 Corporate Sector Developments in Business Fixed Investment Plans (Tankan) Exports s.a. y/y % chg. FY 2016 FY 2017 FY 2018 Average (FY 2004-2016) Real exports (CY 2015=100) CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -2 Mar. Survey June Survey Sept. Survey Dec. Survey Forecast Actual Note: The right chart indicates the revision patterns of fixed investment plans. The horizontal axis represents the point of time when the survey is conducted for each fiscal year. Namely, the first survey for each year (March survey) is on the left, and the last survey (June survey of the following year; actual result) is on the right. The vertical axis represents the year-on-year percent change. All industries including financial institutions. Including software and R&D investment and excluding land purchasing expenses (R&D investment is not included up until the December 2016 survey). There is a discontinuity in the data in December 2017 due to a change in the survey sample. Sources: Bank of Japan; Ministry of Finance. Chart 4 Household Sector Private Consumption Employee Income y/y % chg. -2 s.a., CY 2011＝100 Total cash earnings -4 Number of employees -6 Consumption Activity Index (travel balance adjusted, real) Employee income CY10 -8 06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. For employee income, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Notes: 2. Employee income = total cash earnings ("Monthly Labour Survey") × number of employees ("Labour Force Survey") 3. Figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption (BOJ staff calculations). Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Bank of Japan. Chart 5 BOJ's Forecasts of the Real GDP (April 2018 Outlook Report) s.a., ann., tril. yen Forecast for FY2020 +0.8% Forecast for FY2019 +0.8% Forecast for FY2018 +1.6% Forecast for FY2017 +1.9% (y/y % chg.) Real GDP FY 12 Note: Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Cabinet Office; Bank of Japan. Chart 6 Length of Economic Recovery Period Rank Period Duration February 2002-February 2008 73 months December 2012(Current) 64 months November 1965-July 1970 (Izanagi boom) 57 months December 1986-February 1991 (Heisei boom) 51 months November 1993-May 1997 43 months Note: Economic peaks and troughs are judged based on discussions by experts after waiting for data accumulation. The current recovery phase, which started in December 2012, seems to have lasted for 64 consecutive months by March 2018. Sources: Cabinet Office, etc. Chart 7 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 8 BOJ's Forecasts of the CPI (April 2018 Outlook Report) 2.5 y/y % chg. Forecast for FY2020 +1.8% CPI (all items less fresh food) 2.0 1.5 Forecast for FY2019 +1.8% Forecast for FY2018 +1.3% (y/y % chg.) 1.0 0.5 0.0 -0.5 -1.0 FY 12 Note: Actual figures are adjusted for changes in the consumption tax rate. Forecasts are the medians of the Policy Board members' forecasts excluding the effects of the scheduled consumption tax hike (point estimates). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 9 Firms' Wage-Setting Stance Wage Increases for Full-Time Employees Base Pay Increase (Ratio of Firms Planning to Increase Wages) 0.8 y/y % chg. 0.7 % 0.6 0.5 0.4 0.3 0.2 0.1 0.0 FY 09 Small and mediumsized firms Large firms FY 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. Figures for the base pay increase up to fiscal 2013 are based on the survey by the Central Labour Relations Commission, and those from fiscal 2014 onward are based on the survey by the Japanese Trade Union Confederation (Rengo). Large firms up to fiscal 2013 are defined as firms with 1,000 or more employees, and those from fiscal 2014 onward are defined as firms with 300 or more employees. Figures for fiscal 2018 are based on the fourth aggregate results as of mid-April. 2. Figures for wage increases for full-time employees are based on the survey results concerning firms' wage-setting stance (increases in base pay, bonuses, and lump-sum payments). Sources: Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Teikoku Databank, Ltd. Chart 10 Firms' Price-Setting Stance Change in Output Prices DI (Tankan) DI ("rise"-"fall"), % points Large enterprises Small enterprises -10 -20 -30 -40 -50 CY 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 17 18 Note: All industries. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: Bank of Japan. Chart 11 Inflation Expectations y/y, ann. avg., % 2.5 Economists (6 to 10 years ahead) Firms (5 years ahead) 2.0 Households (over the next 5 years) 1.5 1.0 0.5 0.0 CY05 Notes: 1. Figures for economists are from the "Consensus Forecasts," those for firms are "Outlook for General Prices" in the Tankan survey (all industries and enterprises, average), and those for households are from the "Opinion Survey on the General Public's Views and Behavior." 2. Figures for households exclude inflation expectations by respondents whose annual inflation expectations were ±5% or greater. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bank of Japan. Chart 12 Financial Intermediation Lending Attitude DI of Financial Institutions (Tankan) DI ("accommodative" - "severe"), % points Large enterprises Small enterprises -10 -20 -30 -40 CY 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 17 18 Note: All industries. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: Bank of Japan.
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2018 BOJ-IMES Conference "Central Banking in a Changing World", hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 30 May 2018.
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May 30, 2018 Bank of Japan Opening Remarks at the 2018 BOJ-IMES Conference Hosted by the Institute for Monetary and Economic Studies, Bank of Japan Haruhiko Kuroda Governor of the Bank of Japan I. Introduction Good morning. I am honored to welcome distinguished guests from academia and central banks to the 24th International Conference hosted by the Institute for Monetary and Economic Studies. On behalf of conference organizers, I thank all of you here who have kindly taken time out of your busy schedules to participate in this one-and-a-half-day conference in Tokyo. The topic of this year's conference is "Central Banking in a Changing World." Over the past few years, our conferences focused on monetary policy issues, yielding important insights and suggestions for the conduct of monetary policy after the Global Financial Crisis. This year's conference expands its scope from monetary policy to "central banking," that is to say, central bank policies and operations on the whole. Behind this is the fact that global structural changes in recent years influence not only central bank policies such as monetary and prudential policies, but also central bank operations such as the issuance of currency and the operation of payment and settlement systems, which provide basis for the conduct of central bank policies. As these changes span a wide range of areas, I think it is helpful to briefly outline recent changes in the global economic and financial environment, especially which are deemed important for central banks. II. A Changing World and Central Banks In recent years, the global economic and financial environment surrounding central banks has changed significantly. Global trade activity has gathered strength again following years of lackluster growth in the wake of the Global Financial Crisis. Against the backdrop of the favorable global economic environment, investment activity by financial institutions and other investors around the world has become increasingly active. Along with these developments, economic and financial linkages between countries have been strengthening. This increased interconnectedness is, of course, desirable for the global economy, as it reflects ongoing globalization. But at the same time, partly due to the recent dynamics of political economy and geopolitics, the size of global shocks has been increasing, and the spread of global economic shocks has been presenting a great challenge for central banks. Regarding the conduct of monetary policy, changes in price and wage dynamics have attracted keen attention in both academia and central banks, especially those in advanced economies. As the adverse effects from the Global Financial Crisis subside, the unemployment rate has dropped in many countries and the real economy has improved substantially, partly due to the effects of large-scale macroeconomic policies. Despite these improvements in the real economy, prices and wages have remained sluggish. This phenomenon has recently been labeled the "missing inflation" or "missing wage inflation" puzzle. Looking back on the discussions at our conference last year, adaptive elements in inflation expectations formation were highlighted as a possible factor behind the missing inflation. It is urgent that we explore the mechanism behind the changes in price and wage dynamics especially in advanced economies. Turning to the financial system, after ten years since the outbreak of the Global Financial Crisis, the robustness of the global financial system has been enhanced through the efforts of financial authorities, which include the finalization of Basel III, and those of financial institutions to strengthen their risk management practice. However, it is necessary to pay attention to developments in the so-called shadow banking sector, which is not sufficiently covered by conventional supervision and regulations. Moreover, in recent years, the low profitability of financial institutions, especially in advanced economies, has come to pose a new challenge for global financial stability. As such, central banks are faced with new challenges in terms of financial stability as well. From a longer perspective, central banks are faced with an important challenge posed by innovations in information and communication technology. We see remarkable progress in a wide range of technologies, such as artificial intelligence, big data analysis, and distributed ledger technology. We also see the rapid development of smartphones, social network services, and e-commerce. The application of these technologies in the field of financial business, typically dubbed "FinTech," has already brought about drastic changes in the way payments are made in many countries. These developments are expected to continue in the future, promoting further changes in business models at financial institutions. Of course, over the past several decades, central banks -- in their role as the "bank of banks" -- have made various efforts to improve the safety and efficiency of payment and settlement systems, for example by introducing real-time gross settlement, simultaneous settlement of funds and securities, and simultaneous foreign exchange settlement. Furthermore, with regard to currency issuance, a fundamental role of central banks, some central banks are now exploring the possibility of issuing central bank digital currency. Thus, in the long-run, an era of major transformation may lie ahead even in the core operations of central banking, such as the "issuer of banknotes" and the "bank of banks." III. Conclusion In sum, central banks are facing new challenges both in terms of policies and operations as a result of wide-ranging structural changes in the global economic and financial environment. I hope we will have lively discussions on these challenges and their implications at this conference. Following my remarks, this year's Mayekawa lecture will be given by Professor Raghuram Rajan of the University of Chicago. I am looking forward to learning from his extensive knowledge of banking theory as well as his experiences as Chief Economist of the International Monetary Fund and Governor of the Reserve Bank of India. For the keynote speech, Professor Athanasios Orphanides of the Massachusetts Institute of Technology, our new Honorary Adviser to IMES, will share his views on policy issues, based on his experience both as a former central bank governor and an academic. The paper presentations will focus on the four topics: (1) the sustainability of the low interest rate environment under globalization, (2) the impact of the issuance of central bank digital currency on the effectiveness of monetary policy, (3) the impact of productivity changes on optimal trend inflation, and (4) the mechanism behind missing wage inflation. The final and concluding session will be the policy panel discussion, moderated by the IMES Chief Councillor Kazuo Ueda. As panelists, we welcome James Bullard, President and CEO of the Federal Reserve Bank of St. Louis, and David Ramsden, Deputy Governor of the Bank of England. I hope that this panel will help deepen our understanding on "Central Banking in a Changing World" from both a theoretical and a practical perspective. Of course, compared with the wide range of issues to be discussed, our available time at this conference -- one-and-a-half days -- might be too short. Based on this limitation, the items in the program, especially the paper presentation sessions, are necessarily selective. Nevertheless, by combining paper presentations, lectures, and panel discussions, I hope that the conference as a whole will activate discussion from a variety of perspectives and will deepen our understanding of the issues facing central banks. Thank you for your attention.
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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, Miyagi, 21 June 2018.
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Yukitoshi Funo: Economic activity and prices in Japan, and monetary policy in Japan Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Miyagi, 21 June 2018. * * * I. Recent Economic and Price Developments A. Overseas Developments I would like to begin my speech by talking about overseas economies. The business sentiment of manufacturing firms on a global basis has maintained its improving trend, and the world trade volume has continued to recover. In this situation, overseas economies have continued to grow firmly on the whole. In terms of the outlook, overseas economies are expected to continue growing firmly. According to the World Economic Outlook, released in April 2018 by the International Monetary Fund (IMF), the global growth rate is projected to be 3.9 percent in both 2018 and 2019. Looking at developments by major region, the U.S. economy has been expanding and the European economy has continued to recover. The Chinese economy has continued to see stable growth on the whole. Other emerging economies and commodity-exporting economies have been recovering moderately on the whole, reflecting in particular an increase in exports and the effects of those economies’ stimulus measures. As for the outlook, the U.S. economy is expected to keep expanding and the European economy is projected to continue recovering. The Chinese economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Other emerging economies and commodity-exporting economies are likely to continue their moderate recovery on the whole. Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the U.S. economic policies and their impact on global financial markets, (2) developments in emerging and commodity-exporting economies, (3) negotiations on the United Kingdom’s exit from the European Union (EU) and their effects, and (4) geopolitical risks. In addition, uncertainty is high regarding future developments in trade policies worldwide, and therefore these developments warrant attention. I hold the view that it is important to stay vigilant regarding these risk factors, especially now that overseas economies are continuing to grow firmly. B. Japan’s Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan. Japan’s economy is expanding moderately, with a virtuous cycle from income to spending operating. The real GDP growth rate continued to represent positive growth for eight consecutive quarters on a quarter-on-quarter basis through the October-December quarter of 2017, and thereafter registered minus 0.6 percent for the January-March quarter of 2018 on an annualized quarter-on-quarter basis. While the contribution of net exports on real GDP growth has remained slightly positive, that of domestic private demand has been relatively weak. With regard to the outlook, Japan’s economy is likely to continue its moderate expansion. In fiscal 2018, the economy will probably continue growing at a pace above its potential.1 Namely, 1/5 BIS central bankers' speeches 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, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending. Meanwhile, exports are expected to continue their moderate increasing trend on the back of the firm growth in overseas economies. In terms of Miyagi Prefecture, given that there has been an increase in regularly scheduled domestic and international flights at Sendai International Airport, the number of passengers using the airport in fiscal 2017 registered a record high, and this is expected to contribute to the regional economy through tourism. In fiscal 2019 and 2020, Japan’s economy is expected to continue on an expanding trend supported by external demand, although the growth pace is projected to decelerate due to a cyclical slowdown in business fixed investment and the effects of the scheduled consumption tax hike.2 According to the April 2018 Outlook for Economic Activity and Prices (hereafter the Outlook Report) released by the Bank of Japan, the medians of the Policy Board members’ forecasts of the economic growth rate are 1.6 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020. 1. Under a specific methodology, Japan’s potential growth rate is estimated to be in the range of 0.5-1.0 percent. 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. 2. It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to food and beverages — excluding alcohol and dining-out — and newspapers. Policies concerning the provision of free education are also factored into the forecasts, based on information available as of April 2018. 2. Prices Let me now explain price developments. Although the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.5-1.0 percent, it has continued to show relatively weak developments compared to the economic expansion and the labor market tightening, remaining at around 0.5 percent excluding the effects of energy prices. With regard to the outlook, the year-on-year rate of change in the CPI (all items less fresh food) is likely to continue on an uptrend and increase toward 2 percent, mainly on the back of the improvement in the output gap and the rise in medium- to long-term inflation expectations. 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 April 2018 Outlook Report are 1.3 percent for fiscal 2018 and — on a basis excluding the direct effects of the scheduled consumption tax hike — 1.8 percent each for fiscal 2019 and 2020.3 1. 3Assuming that the rise in the consumption tax will be fully passed on to prices of taxable items, excluding those to which a reduced tax rate will be applied, the effect of the October 2019 consumption tax hike on the year-on-year rate of change in the CPI (all items less fresh food) for October 2019 onward is estimated to be 1.0 percentage point; the effect for fiscal 2019 and 2020 is estimated to be 0.5 percentage point for each year. It also is assumed that the effects of policies concerning the provision of free education will not be reflected in the CPI, as statistical treatment of these effects is not yet decided. II. Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I would like to discuss several points that I think deserve particular attention in terms of realizing the outlook for economic activity and prices that I mentioned earlier. A. Supply-Demand Conditions in the Labor Market and the Income Situation Let me first talk about supply-demand conditions in the labor market and the income situation. As 2/5 BIS central bankers' speeches the economy has continued its moderate expansion, the output gap has continued to improve; the figure for the October-December quarter of 2017 — the most recent data available – was in positive territory of around 1.5 percent. Furthermore, supply-demand conditions in the labor market have continued to tighten steadily. The year-on-year rate of increase in the Labour Force Survey-based number of employees accelerated to the range of 2.0-3.0 percent, and against this backdrop, the active job openings-to-applicants ratio has risen steadily. Moreover, a perception of labor shortage suggested by the employment conditions diffusion index (DI) in the Tankan (Short-Term Economic Survey of Enterprises in Japan) has heightened, and the unemployment rate has been around 2.5 percent recently, which is slightly below the structural unemployment rate. These indicators of supply-demand conditions in the labor market show that the degree of labor market tightness has been at around the level last seen in the first half of the 1990s or in the first half of the 1970s. In terms of the outlook, as Japan’s economy is likely to continue on a growing trend at a pace above its potential, it is expected that the number of employees will keep increasing and that the supply-demand conditions in the labor market will continue to tighten steadily. Amid such supply-demand conditions in the labor market, the year-on-year rate of increase in hourly scheduled cash earnings of part-time employees, which are responsive to supply-demand conditions in the labor market, has exhibited relatively high growth recently of around 2.0 percent on average. On the other hand, the increase in overall employees’ hourly cash earnings in nominal terms has remained moderate, and total cash earnings per employee also have risen moderately, albeit with some fluctuations. Going forward, the rate of increase in overall employees’ hourly cash earnings is expected to accelerate as that in base pay has started to do so as well. However, there is a risk that firms will remain cautious with their decisions on wage setting, and in this context, I am paying attention to their stance regarding wages going forward. B. Prices Next, I will turn to price developments, taking into account supply-demand conditions in the labor market and the income situation. The year-on-year rate of change in the CPI (all items less fresh food and energy) has been at around 0.5 percent. While the fact that the pace of increase in the CPI has been moderate compared to the economic expansion and the labor market tightening is partly attributable to the sectoral shock of such factors as price declines at major supermarket chains mainly resulting from intensifying competition with other types of retail businesses, this reflects the fact that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households. There have been moves by firms to make efforts to absorb a rise in labor costs by increasing labor-saving investment and streamlining their business process, while limiting wage increases — which correspond to the labor shortage — mainly to part-time employees. In the outlook for prices, the main factors that determine inflation rates — the output gap and inflation expectations — are assessed as follows. First, the output gap has improved steadily, and it is projected to continue expanding moderately within positive territory in fiscal 2018, both on the labor and capital sides, reflecting the increase in demand at home and abroad. Going forward, although such expansion is likely to pause, mainly due to the effects of the scheduled consumption tax hike, the output gap is expected to remain substantially positive. Second, medium- to long-term inflation expectations have been more or less unchanged recently. As for the outlook, such expectations are likely to follow an increasing trend and gradually converge to around 2 percent on the back of the following: (1) in terms of the adaptive component, with the improvement in the output gap, firms’ stance is likely to gradually shift toward raising wages and prices, and (2) in terms of the forward-looking component, the Bank will pursue monetary easing through its strong commitment to achieving the price stability target. Nevertheless, if competition among firms — which provide goods and services that are difficult to differentiate — intensifies further, prices of these goods and services may not rise even if the 3/5 BIS central bankers' speeches output gap widens within positive territory. Also, there is a risk that a rise in firms’ and households’ inflation expectations will lag behind if it takes time for firms’ stance to shift toward raising wages and prices and inflation consequently remains relatively sluggish. Therefore, I believe that it is necessary to carefully examine developments in this regard. III. Conduct of Monetary Policy Let me now turn to the Bank’s monetary policy. The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and has been conducting monetary policy to achieve this target at the earliest possible time. What is important here is that it conducts monetary policy based on the principle that the policy shall aim at “achieving price stability, thereby contributing to the sound development of the national economy,” as stipulated in the Bank of Japan Act. In other words, the Bank is not simply trying to achieve a rise in prices by setting a specific deadline by which the target will be achieved. On this point, let me note that the April 2018 Outlook Report ceased to provide a description on the projected timing of achieving the 2 percent price stability target, so as to clarify that the timing is not a deadline by which the target will be achieved. If prices rise in a stable manner and firms and households start to behave based on this assumption, prices of goods and services will rise, which in turn will increase firms’ sales and profits. With such increases, wages would rise accordingly, leading to more active consumption. The Bank is aiming for an economy with a virtuous cycle from income to spending operating as the price stability target of 2 percent is achieved. With a view to achieving this target, the Bank has been pursuing powerful monetary easing, considering developments in economic activity and prices, as well as financial conditions, under Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control introduced by the Bank in September 2016. This policy framework 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. At present, according to the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. The second component is an inflationovershooting 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. I would like to summarize economic and price developments in Japan. The economy has continued its moderate expansion, but prices have continued to show relatively weak developments, mainly against the background that firms’ wage- and price-setting stance has remained cautious. Regarding the outlook for prices, risks are skewed to the downside, especially concerning developments in medium- to long-term inflation expectations, and this warrants attention. Financial conditions are highly accommodative. There is no sign so far of excessively bullish expectations in asset markets or in the activities of financial institutions. Furthermore, prolonged downward pressure on financial institutions’ profits under the continued low interest rate environment could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. However, at this point, these risks are considered not significant, mainly because financial institutions have sufficient capital bases. Given this situation, the momentum toward achieving the price stability target of 2 percent is being maintained. Nevertheless, there is still a long way to go to achieve the target. I believe that it is necessary that the Bank continue to persistently pursue powerful monetary easing under 4/5 BIS central bankers' speeches QQE with Yield Curve Control. IV. Challenges for Japan’s Economy I would now like to express my thoughts regarding the current situation for Japan’s economy from a longer-term perspective. According to the Bank’s estimates, the potential growth rate, which was about 4 percent in the latter half of the 1980s, has been in the range of 0.5-1.0 percent recently. It can be said that Japan’s growth potential has been sluggish, mainly reflecting the population decline and low productivity growth. Yet, when looking at the economy in detail, we see that initiatives toward structural reforms and growth strategy have proceeded among a wide range of entities, in a situation where the output gap has widened within positive territory and further tightening has been seen in terms of both labor and capital. I expect that such initiatives will lead to raising the growth potential of Japan’s economy. Let me point to some examples. On the labor front, an increase in employment has been seen not only for non-regular employees, but also regular employees. At the same time, there has been progress in terms of making extensive use of diverse human resources, including women, the elderly, and foreigners. In addition, changes have begun to be observed in the seniority-based wage system. These developments can be perceived as one type of changes occurring in Japan’s labor market, which previously had been rigid. My view is that bringing out the potential labor capacity that has not been utilized will likely boost Japan’s labor productivity, which is low compared with that of the U.S. and European economies. On the capital front, an increasing number of firms have been taking measures to establish new factories and expand production capacity against the background of such factors as supply-side constraints. Furthermore, in response to the tight labor market conditions, firms are making labor-saving investments not only at production sites but in various workplaces. At the same time, they are proceeding with streamlining and sophistication of business process. For example, the financial industry is moving ahead with advancing financial technology as well as making efforts to improve business efficiency. In the retail industry, while progress is being made with saving labor at stores, integration of sales at brick-and-mortar stores and online sales is also taking place. If such initiatives toward structural reforms and growth strategy proceed, Japan’s growth potential will likely rise. However, attention needs to be paid to the point that these initiatives are diverse and their pace of progress is not uniform. For example, the situation of labor shortages varies depending on types of job and industry. For this reason, it is necessary to keep a close watch on whether any imbalances arise amid increasing work demand across Japan. Let me note that raising growth potential is a time-consuming task. Therefore, while the Bank’s conduct of monetary policy stimulates aggregate demand and suitably tight supply-demand conditions are being maintained, a virtuous cycle in which active demand encourages progress in various initiatives should remain intact for a long period of time. I believe that, with a view to achieving its price stability target and realizing sustainable economic growth in a coordinated manner, the Bank should continue with its monetary easing policy and firmly support the various initiatives taken by a wide range of entities. 5/5 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 meeting with business leaders, Nagano, 5 July 2018.
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July 5, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Nagano Takako Masai Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices I would like to start my speech with a look at developments in economic activity and prices. At the Monetary Policy Meeting (MPM) held on April 26 and 27, 2018, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices through fiscal 2020. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas Economies Let me first touch on developments in overseas economies. The Bank's assessment is that overseas economies have continued to grow firmly on the whole. In terms of the outlook, global production and trade activity in the manufacturing sector are likely to be firm and both advanced and emerging economies are projected to grow in a well-balanced manner. A similar view was presented in the World Economic Outlook (WEO) released in April 2018 by the International Monetary Fund (IMF). Looking at developments by major region, the U.S. economy is expected to keep expanding and the European economy is also projected to continue recovering. The Chinese economy will likely continue to broadly follow a stable growth path as the authorities conduct fiscal and monetary policy in a timely manner. Other emerging economies and commodity-exporting economies are likely to continue their moderate recovery on the whole. There are both upside and downside risks to overseas economies, and I consider the outcome of protectionist moves in the United States as the downside risk that is of greatest concern. In the short term, growing uncertainty over U.S. trade policy will likely lead to a sharp rise in volatility in global financial markets. This could in turn exert adverse effects on the sentiment of firms and households. In the medium to long term, if such protectionist moves were to increase globally, this may significantly affect the business strategies of global firms, and the subsequent impact on the capital flow of trade and investment cannot be ignored. Therefore, I will closely monitor whether the protectionist moves entail the risk of causing any imbalances in the global capital allocation. B. Japan's Economy and Price Developments 1. Current situation Now I would like to move on to developments in economic activity and prices in Japan. The Bank's assessment is that Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. Industrial production has been on an increasing trend, reflecting the increases in demand both at home and abroad, and labor market conditions have continued to tighten steadily. As a result, the output gap -- which shows the utilization of labor and capital -- has widened steadily within positive territory. On the domestic demand side, business fixed investment has continued on an increasing trend with corporate profits and business sentiment maintaining their improving trend. According to the June 2018 Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment plans for fiscal 2018, especially those of large enterprises, showed firms' solid stance. This is evidenced by, for example, the fact that fixed investment plans on a basis close to GDP definition saw a year-on-year increase of 8.7 percent -- a level clearly exceeding the past average of 4.4 percent for the June Tankan surveys during the period of fiscal 2004-2017. Turning to the household sector, housing investment has been weakening somewhat, but private consumption has been increasing moderately, albeit with fluctuations, against the background of steady improvement in the employment and income situation. Exports have been on an increasing trend on the back of the firm growth in overseas economies that I mentioned earlier. On the price front, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.5-1.0 percent, reflecting a rise in energy prices. 2. Outlook I will now look at the outlook for Japan's economy during the projection period, which covers from fiscal 2018 through fiscal 2020. The economy is likely to continue its moderate expansion. Domestic demand is likely to follow an uptrend, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending. Exports are expected to continue their moderate increasing trend along with the growth in overseas economies. Reflecting this outlook, the economy is likely to continue growing at a pace above its potential in fiscal 2018. From fiscal 2019 through fiscal 2020, the economy is expected to continue on an expanding trend supported by external demand, although the growth pace is projected to decelerate due to a cyclical slowdown in business fixed investment and the effects of the scheduled consumption tax hike. Looking at the medians of the Policy Board members' forecasts in the April 2018 Outlook Report, the real GDP growth rate is projected to be 1.6 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020. Let me explain the outlook in detail by major component. First, business fixed investment is likely to continue increasing. This is because, in a situation where extremely stimulative financial conditions are maintained, fixed investment will be positively affected by an improvement in corporate profits, the materialization of the effects of projects conducted under the Fiscal Investment and Loan Program as well as the effects of investment-enhancing tax incentives, and a moderate improvement in growth expectations. Specifically, an increase is likely to be seen in investment such as, (1) that intended for domestic capacity expansion in line with the economic expansion; (2) that related to the 2020 Olympic Games and urban redevelopment projects; (3) that aiming at improving efficiency and saving labor in order to deal with, for example, the labor shortage; and (4) in research and development for growth areas. Private consumption is expected to follow a moderate increasing trend, due mainly to an increase in employee income as well as replacement demand for durable goods, and housing investment is expected to remain more or less flat. Exports will likely continue their increasing trend for the time being, as those of capital goods and IT-related goods, in which Japan has a comparative advantage, are likely to be firm. Thereafter, they are expected to continue their moderate increasing trend, due mainly to the improvement in overseas economies. Industrial production will likely continue to increase firmly for the time being, and thereafter is projected to continue on a moderate increasing trend. The year-on-year rate of change in the CPI (all items less fresh food) is likely to increase toward 2 percent. This is because, although upward pressure of energy prices is likely to wane moderately, firms are likely to gradually shift their stance toward raising wages and prices with the improvement in the output gap, and inflation expectations are expected to gradually rise. Looking at the medians of the Policy Board members' forecasts in the April 2018 Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is projected to be 1.3 percent for fiscal 2018 and -- on a basis excluding the effects of the scheduled consumption tax hike -- 1.8 percent each for fiscal 2019 and 2020. Developments in prices since the release of the April 2018 Outlook Report have been slightly weak relative to what had been assumed, but I believe that the momentum for price rises remains intact. I believe that there are the following risks to the outlook. Risks to Japan's economic activity are developments in overseas economies, such as the U.S. economic policies and geopolitical risks, firms' and households' medium- to long-term growth expectations, fiscal sustainability in the medium to long term, as well as the effects of the consumption tax hike scheduled to take place in October 2019. Risks to prices, in addition to the risks that I just mentioned, are developments in firms' and households' medium- to long-term inflation expectations, the fact that there are items for which prices are not particularly responsive to the output gap, as well as developments in foreign exchange rates and international commodity prices going forward. In assessing the outlook for developments in economic activity and prices, I am paying particular attention to the effects of the scheduled consumption tax hike. On this point, the Bank estimated in the April 2018 Outlook Report that the net burden on households around the time of the consumption tax hike was expected to be smaller than that of the two previous consumption tax hikes. In fiscal 1997, apart from the hike in the consumption tax rate by 2 percentage points to 5 percent, there were additional increases in the household burden in the form of a termination of income tax reductions and an increase in medical costs resulting from reforms of medical care insurance. Together, these were estimated to have resulted in an increase of over 8 trillion yen in the net burden on households. In fiscal 2014, the tax rate was raised by 3 percentage points to 8 percent, and the increase in the net burden on households was estimated to have been about 8 trillion yen. Although measures were taken to reduce the burden, such as increases in welfare benefits, the effects of such measures were lessened by an increase in pension-related burdens. On the other hand, in fiscal 2019, even though the consumption tax rate is scheduled to be raised by 2 percentage points to 10 percent, there are plans to implement a number of measures to mitigate the burden -- such as a reduced tax rate and an increase in welfare benefits for pensioners -along with the provision of free education. As a result, the net burden on households is estimated to be about 2 trillion yen. Of course, these estimates merely indicate mechanical computations of the net burden on households, and there is inevitably considerable uncertainty as to the impact of the consumption tax hike mainly because the impact on the sentiment of households may differ significantly according to their financial conditions. Given the recent favorable employment situation, the sentiment of households whose main source of income is wages is expected to remain reasonably firm. Meanwhile, households whose main source of income is pensions are expected to be significantly affected by developments in consumer prices of such basic items as food and gasoline, although there are plans to implement measures to mitigate the burden. I believe that it is necessary to carefully monitor the balance of these factors. II. The Bank's Monetary Policy Next, I will talk about the Bank's monetary policy. A. Making Financial Conditions Highly Accommodative Since the introduction of quantitative and qualitative monetary easing (QQE) in 2013 with a view to achieving the price stability target of 2 percent, the Bank has been maintaining highly accommodative financial conditions by consistently pursuing strong monetary easing. The Bank has been trying to push down the entire yield curve through its large-scale purchases of Japanese government bonds (JGBs) under the framework which I will touch upon later. The maintenance of highly accommodative financial conditions has led to an improvement in the funding conditions of firms. Importantly, availability of funds has been improving further among small firms in particular. Financial institutions' lending attitudes as perceived by firms are becoming very proactive. In the Tankan surveys, the diffusion index (DI) for financial institutions' lending attitudes for small firms has been at a high level last seen at the end of the 1980s. The same can be said about the financial positions of firms. As suggested by the DI for firms' financial positions in the Tankan surveys, the momentum for improvement in financial positions has recently been strengthening, particularly among small firms. This improvement in firms' funding conditions is leading to firms' solid stance on business fixed investment, which I mentioned earlier, although the pace of this increase is moderate relative to the high level of corporate profits. This highlights, among other factors, the feature of the current phase of economic recovery in which both domestic and external demand have been driving the economy in a relatively well-balanced manner.1 Under these circumstances, the economic activity of firms and households has become invigorated, and the output gap has improved steadily. The Bank believes that it has strongly supported Japan's economic activity by maintaining such accommodative financial conditions. B. QQE with Yield Curve Control The framework of QQE with Yield Curve Control adopted by the Bank consists of two major components. The first component is "yield curve control," in which the Bank controls short-term and long-term interest rates. In the current framework, introduced in September 2016, the Bank sets the short-term policy interest rate and the target level of the 10-year JGB yields as its operating targets. At present, in the guideline for market operations, the Bank sets the short-term rate at minus 0.1 percent and the target level of JGB yields at around 0 percent, According to the "Survey of Corporate Attitudes towards Capital Investment in 2018" released by Teikoku Databank, Ltd. on May 16, 2018, in the case of capital investment to the value of 50 million yen or more, about half of firms raised funds for such investment by borrowing from financial institutions. and conducts JGB purchases so as to achieve this target level. These large-scale purchases of JGBs enable the maintenance of highly accommodative financial conditions, as discussed earlier. The second component is an "inflation-overshooting commitment," in which the Bank commits itself to continuing to expand the monetary base until the year-on-year rate of increase in the observed CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. While it is originally allowed to exceed 2 percent as the price stability target needs to be achieved on average over the business cycle, the Bank's commitment demonstrates its unwavering determination not to terminate monetary easing before the price stability target of 2 percent is achieved. In the case of Japan, as is often pointed out, we have yet to reach the situation where people's perception of prices, or so-called inflation expectations, is anchored around the price stability target. In this situation, sending such a strong message is of great significance in anchoring inflation expectations at 2 percent. C. The Need for Persistent, Strong Monetary Easing While the Bank's strong monetary easing has showed its intended effects through the maintenance of highly accommodative financial conditions, it is also true that observed prices have not yet been sufficiently firm relative to the steady improvement in economic activity. As it has become clear that the deflationary mindset is more persistent than was initially assumed, the following opinions about the Bank's monetary policy have increasingly been heard. Specifically, some claim that the price stability target of 2 percent is not needed in Japan. Others -- while acknowledging the need for the 2 percent target -- question the continuation of strong monetary easing. They claim, for example, that the level of interest rates should be adjusted by taking into consideration financial institutions' profits, among other factors. I will discuss the first opinion in detail later. Let me first address the second opinion. At each MPM, the Bank decides the guideline for market operations based on a comprehensive consideration of (1) the possible spillover effects on bank lending rates and issuance rates for corporate bonds, (2) the impact on economic activity, and (3) the impact on financial functioning, among other factors. As the Bank stated in the Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of QQE, released in September 2016, the impact on financial functioning should be taken into consideration when conducting monetary policy. In fact, it warrants attention that financial institutions' lending margins have been shrinking due, for example, to strong monetary easing and intensifying competition among banks. It should be noted, however, that since the 1990s, deposit and lending margins have been on a narrowing trend with low economic growth, and in that sense, this has long been a major challenge for financial institutions. In addition, it is an issue of urgent priority to take measures from a medium- to long-term perspective to respond to FinTech and other technological innovations and to changes in the external environment, such as the decline in both population and the number of firms. Structural problems -- which will have an impact on financial institutions' business environment -- and the effects of monetary easing should be analyzed and discussed independently of each other. At present, Japan's economy has finally reached a state of being no longer in deflation, which is commonly defined as a sustained decline in prices. Given this, it is necessary to ensure that the economy fully overcomes deflation. Needless to say, the Bank does not aim solely at price rises. It is emphasized in the joint statement by the government and the Bank released in 2013 that the achievement of the price stability target of 2 percent should be accompanied by the strengthening of the growth potential of the economy.2 In addition, in a speech delivered in May 2013, the month following the introduction of QQE, then Deputy Governor Hiroshi Nakaso said that "[t]he price stability target we aim at should be achieved in a virtuous cycle in which the real economy improves in a balanced manner, accompanied by an increase in corporate profits, employment, and wages."3 On the other hand, as I will discuss in detail later, it is extremely important that Japan's economy fully overcomes "Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth," January 22, 2013. Hiroshi Nakaso, "Basic Idea Underlying 'Quantitative and Qualitative Easing'," Speech at the International Conference Organized by the Economic and Social Research Institute, Cabinet Office, Government of Japan, May 31, 2013. deflation, which is a challenge that the economy has faced for many years. Amid the persistent deflationary mindset, it may take some time to achieve the price stability target of 2 percent. While strong monetary easing has been maintained for a long period, it is appropriate to continue with strong monetary easing in a persistent and sustainable manner, while being more careful than ever when examining developments in economic activity and prices as well as financial conditions. III. The Price Stability Target: Why Is It 2 Percent? Five and a half years have passed since the Bank introduced the price stability target in 2013, but the necessity of the 2 percent price stability target in terms of the year-on-year rate of change in the CPI seems to have not yet been widely accepted by the public. The Bank's conduct of monetary policy is aimed at "achieving price stability, thereby contributing to the sound development of the national economy." Price stability is defined conceptually as "a state where various economic agents including households and firms may make decisions regarding such economic activities as consumption and investments without being concerned about the fluctuations in the general price level."4 While it seems that the intuitive desirability of price stability may be readily accepted by the public, defining price stability as a specific numerical value of a particular price index makes it difficult to gain understanding since the definition must inevitably be based on somewhat arbitrary grounds. Overseas central banks also face similar difficulties. In a speech given in January 2017, then Federal Reserve Board Chair Janet L. Yellen -- noting that price stability does not mean having no inflation whatsoever -- explained that, "[b]ased on research and decades of experience, we define [the level of inflation considered as 'price stability'] as 2 percent a year."5 She then added that most other major central banks adopt an inflation objective similar to the 2 percent price stability defined by the Federal Reserve. If high inflation is undesirable for the public, the question naturally arises as to why central Bank of Japan, "The 'Price Stability Target' under the Framework for the Conduct of Monetary Policy," January 22, 2013. Janet L. Yellen, "The Goals of Monetary Policy and How We Pursue Them," Remarks at the Commonwealth Club, San Francisco, California, January 18, 2017. banks do not aim for an inflation rate of 0 percent.6 A number of technical reasons aside, among those central banks that define price stability as an annual inflation rate of 2 percent, the common answer is that this creates a buffer against falling into deflation.7 This buffer has the following dual meaning: (1) securing a safety margin to avoid deflation as far as possible; and (2) securing room for central banks to reduce interest rates -- that is, to put it simply, since a nominal interest rate level that is neutral to economic activity is determined by the sum of the economy's potential growth rate and an inflation rate, either a rise in potential growth rates or in inflation rates produces an equivalent rise in the level of the neutral nominal interest rate, thereby creating room for monetary easing through interest rate control. I would like to touch on two points relating to this issue, which I believe are important. The first is the costs of deflation. In Japan, the perception that "deflation should be avoided at all costs" seems to be weaker than in other countries. Particularly following the 2008 global financial crisis, Japan's experience of facing deflation and economic stagnation for a prolonged period has been referred to abroad as "Japanization," and studies have been made to avoid the situation that Japan's economy has faced. One example is a special report published in the American magazine The International Economy in 2017, entitled "Is the World at Risk of the 'Japan Disease'?"8 Authorities, scholars, and experts dealing with economic and financial issues around the world are still engaged in active discussions over the possibility of their respective economies falling into a situation similar to that experienced by Japan's economy and on measures to avoid such an outcome. Japan's deflation has been receiving attention globally because protracted deflation, even when it is mild and does not produce a deflationary spiral, is viewed as imposing a great burden on the economy for a prolonged period. It appears that similar questions are also being raised in the United States, where people's inflation expectations seem to be anchored at around 2 percent. Then Federal Reserve Chair Janet L.Yellen referred to this point in the speech at the Commonwealth Club cited above. As indicated by Japan's experience of suffering from prolonged deflation, the difficulty of overcoming deflation has become well known. This is perhaps one of the factors that motivated major central banks to reach a consensus of defining price stability as an annual inflation rate of 2 percent. "Is the World at Risk of the 'Japan Disease'?" The International Economy, Summer 2017. Why exactly is deflation problematic? For households, it is problematic because it often goes hand-in-hand with a decline in their wages. There may be some who argue that, putting aside wages, deflation is actually a desirable phenomenon because it increases real income. Indeed, it may be true that a transient mild deflation would cause no particularly significant problems. If it continues for a protracted period, however, households will ultimately be forced to bear the burden through economic stagnation. Deflation becomes a factor weighing heavily on the economy through a number of channels. One of the well-known textbook examples of the problem is that, when deflation continues, households and firms -- in anticipation of further falls in prices of goods and services and continued uncertainty -- tend to opt for postponing expenditure and reining in borrowing. Such behavior could lead the overall economy to prolonged weak growth and deflation, thereby creating a vicious cycle within the economy. Furthermore, there also is the complex problem that if deflation drags on, it becomes embedded in the habits of people, making an exit from deflation even more difficult. In the case of Japan, it seems that achieving the price stability target of 2 percent has been made more difficult by the fact that the experience of over 15 years of deflation has become entrenched in people's mindset. In light of these points, a complete exit from deflation under the price stability target of 2 percent will ultimately be desirable for households in Japan. While the rest of the world is trying to learn the lessons of Japan's long period of deflation, we should also face our own experience more squarely. The second point concerns the importance for Japan of pursuing price increases that are more or less equivalent to those of other countries. Two percent inflation is often referred to as the global standard. More essentially, however, it should be emphasized that the realization of similar inflation rates by Japan and other countries will bring stability of exchange rates in the long run, and ultimately the stability of financial markets and corporate activities. More specifically, from the perspective of corporate managers, while exchange rates fluctuate as a matter of course, if the rates come to be perceived as no longer having long-term trends, reflecting differences in inflation rates at home and abroad, they will no longer significantly undermine business sentiment, albeit with a certain degree of fluctuation. In a situation where further globalization of Japan's economy is expected, Japan must move in tandem with overseas economies to achieve stable growth, in the sense of domestic prices rising to the same degree as those in other economies.
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Presentation by Mr Makoto Sakurai, Member of the Policy Board of the Bank of Japan, and Mr Masahiko Kataoka, Director, Secretariat of the Policy Board of the Bank of Japan, at the 30th Villa Mondragone International Economic Seminar, Rome, 25 June 2018.
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June 25, 2018 Bank of Japan Hysteresis and Sluggish Growth in Wages and Prices: The Case Study of Japan Presented at the 30th Villa Mondragone International Economic Seminar in Rome Makoto Sakurai Member of the Policy Board Masahiko Kataoka Director, Secretariat of the Policy Board (The views expressed here, as well as any remaining errors, are those of the authors and should not be ascribed to the Bank of Japan.) Abstract Despite the recent strong economic recovery, growth in wages and prices has been sluggish across the globe. Japan has come to face this issue ahead of any others. The policy authorities of each economy could learn something from the case study of Japan. This article will examine some factors that have restrained growth in wages and prices in Japan, and discuss the desired policy responses to address this issue. In relation to the theme of this session – inequality, wages, and growth – factors responsible for this curb on growth in wages and prices can be divided primarily into two categories. One is "hysteresis" brought about by past serious economic downturns. Serious economic downturns have left persistent damage to the supply side of the economy through various channels, including an increase in the number of "discouraged workers" and "involuntary non-regular employees," a slowdown in (human) capital accumulation, and the inefficient business processes that took root under excessive competition. This damage has created the slack that is easing the upward pressure on prices that has come from an expansion in demand. Besides this hysteresis, the second category includes factors of a more structural nature that reduce upward pressure on wages amid an increase in labor demand. These factors include: an increase in labor participation of women and the elderly, whose wages are relatively low; firms' and households' anxiety for the future; and technological innovation in the IT industry, such as robotic process automation (RPA) and artificial intelligence (AI). If the supply-demand conditions continue to tighten, the factors in the former category will eventually mitigate with hysteresis reversing. Moreover, the reversal of hysteresis is a desirable change, in that it can enrich people's lives. To bring this about, the Bank is expected to continue to maintain the adequate level of tightening of supply-demand conditions, thereby supporting the reversal of hysteresis. Given that it could take some time to reverse hysteresis, the Bank needs to conduct monetary policy while closely monitoring the economic and financial conditions so that no severe distortion will be created under the prolonged accommodative financial condition. Meanwhile, factors in the latter category need to be addressed in a more structural way. Monetary policy and structural policy must nonetheless address the issue interactively, since these factors are somewhat related to each other. This article consists of three sections. Sections I and II are assessments of the factors responsible for sluggish growth in wages and prices, jointly written by Makoto Sakurai and Masahiko Kataoka. Section III is a personal assessment by Makoto Sakurai of the current situation and what policy responses should be made. I. Reversal of Hysteresis Serious economic downturns create persistent damage to the economy. 1 Since the 1990s, the growth trend in Japan's economy marked a significant fall following each serious economic downturn. This is attributable to persistent damage to the supply side of the economy through various factors such as an increase in the number of "discouraged workers," who are deterred from seeking employment despite wanting to work, and "involuntary non-regular employees," who reluctantly accept employment as non-regular employees, together with a slowdown in (human) capital accumulation, and the inefficient business processes that took root under excessive competition. While an economic downturn is fundamentally assumed to be a cyclical, or demand-side, phenomenon, the mechanism by which it influences the medium- to long-term growth trend through damage to the supply capacity is referred to as "hysteresis." It has also been pointed out that hysteresis that arose in earlier periods can be reversed to a certain degree amid robust aggregate demand. 2 In Japan, the uptrend in economic growth has been increasing recently in a situation where aggregate demand has continued to increase strongly, and the aforementioned damage to the supply side of the economy is also being mitigated. Under the circumstances, growth in wages and prices has been contained. Specifically, the expansion of the supply side of the economy due to the reversal of hysteresis eases the upward pressure on wages and prices that has come from an increase in aggregate demand. In other words, hysteresis that arose in earlier periods has created the slack that is easing the tightening of supply-demand conditions. Past economic downturns in Japan have been more serious, and even more frequent, than in other advanced economies. Against this background, the hysteresis in Japan might remain relatively deep-rooted (Chart 1). For example, Cerra and Saxena (2008) conducted an empirical analysis of past financial and political crises and found that, in many serious crises, the adverse impact on the growth rate persisted even after a decade. For example, Ball (2015) states that past damage to the supply capacity can be reversed under a "high-pressure economy" -- that is, a continued expansion of the economy -- and that the Federal Reserve might be justified in maintaining a low-interest rate environment for a longer period, as long as inflation expectations are anchored. Yellen (2016) argues that, although this point deserves consideration, the risk of an accumulation of financial imbalances and price instability warrants attention. In what follows, the changes that have taken place in Japan's supply capacity since the 1990s will be discussed by focusing on hysteresis associated with labor input and labor productivity. A. Labor Input 1. Decline in the labor force participation rate A decline in the labor force participation rate is one of the channels through which hysteresis associated with labor input occurs. There are a number of reasons why people find it increasingly difficult to get a job as their period of unemployment becomes longer: for example, their abilities diminish relatively since they are unable to enhance their practical skills through work experience, and prolonged unemployment becomes a stigma in their career.3 Consequently, some of those who are unemployed for a prolonged period will give up seeking employment and become discouraged workers, who are regarded as being excluded from the labor force population. In fact, after the bursting of the asset bubble in the early 1990s, the labor force participation rate in Japan turned down sharply, and the labor force population also started to decline. However, the labor force participation rate has recently turned to an uptrend amid the long period of continued economic expansion. As news reports about labor shortages increase and firms dig deeper into the labor market by, for example, relaxing their recruitment criteria, people who once gave up seeking employment have now started to participate in the labor market again. Reflecting these developments, the number of discouraged workers is declining (Chart 2). Along with the factors which have led to labor participation of women and the elderly as mentioned later, the size of labor force has increased by 2.21 million in the six years since the beginning of 2012, and this accounts for nearly two thirds of the 3.34 million increase in the number of employed persons. Referring to firms' reactions to job applicants' résumés, Kroft and Lange (2012) showed that, if unemployment exceeds a certain period of time, this will make it harder for the applicant to find employment because of stigmatization and other factors. 2. Increase in involuntary non-regular employees Another channel through which hysteresis is generated is the increase in the number of involuntary non-regular employees, who, despite wanting to become regular employees, reluctantly accept employment as non-regular employees, due mainly to "the absence of firms that will employ them as regular employees." Job offers for regular employees decrease and the number of involuntary non-regular employees increases when firms shift to hiring non-regular employees to cut labor costs and secure employment flexibility in response to an economic downturn. It has been pointed out that if someone begins working as a non-regular employee upon graduation, they are subsequently less likely to be employed as a regular employee. 4 Since working hours for non-regular employees are relatively short, an increase in the number of involuntary non-regular employees leads to a decline in labor input. Since the 1990s, the number of involuntary non-regular employees has increased substantially in Japan, as firms have sought to benefit from employing non-regular employees. That being said, the number of involuntary non-regular employees has recently begun to decline amid an increase in labor demand. With a view to securing additional labor force and retaining existing human resources, firms are increasing the recruitment of regular employees and converting non-regular employees into regular employees. While the number of involuntary non-regular employees has decreased by 0.85 million in the five years since early 2013, the number of regular employees has increased by 1.35 million (Chart 3). B. Labor Productivity 1. Sluggishness in business fixed investment Sluggishness in business fixed investment can be cited as one of the channels through which hysteresis associated with labor productivity is generated. Such sluggishness leads to Genda et al. (2010) examined changes in type of employment by analyzing the data of labor statistics. The results showed that the type of employment upon graduation, especially for those with lower education, has an effect on future employment prospects. The following were given as reasons: non-regular employees do not have adequate chance of being trained; and the lack of experience in being employed as a regular employee could be viewed in a negative light by recruiters. a deceleration in capital accumulation. An increase in aging capital stock and delays in the introduction of new technology contributes to a sluggish rise in total factor productivity (TFP). 5 Since the bursting of the asset bubble in the early 1990s, Japanese firms have reined in fixed investment as they have been burdened with excess production capacity and excess debt, with the banking sector tightening their lending attitudes. Since then, business fixed investment has been contained within the scope of depreciation expenses over the years. As a consequence, aging capital stock has increased and the introduction of new technology has tended to be delayed (Chart 4). 2. Reduction in the cost of education and training Firms' attempts to cut costs by reducing spending on education and training leads to a deceleration in the accumulation of human capital and a sluggish rise in labor productivity. This is related to the aforementioned increase in the number of involuntary non-regular employees. While firms address skills development for regular employees through systematic on-the-job training (OJT) and other programs, both on-site and off-site, they tend to avoid proactive investment in the training of non-regular employees, who are not intended to be employed for a long period in the first place. Since the 1990s, Japanese firms have shifted to hiring temporary workers rather than regular employees and have endeavored to minimize the cost of education and training against the background of labor costs being a burden on corporate profits due to excessive employment (Chart 5). 3. Excessive competition among firms Excessive competition among firms stemming from protracted deficient demand may also have contributed to the decline in labor productivity. Since the 1990s, many Japanese firms have been drawn into fierce competition, cutting excessively the price of their products and providing extravagant services. As a result, inefficient work practices and the provision of excessively high-quality services for their prices have been seen in some industries. For example, the proportion of businesses in the wholesale and retail industries operating 24 hours a day increased rapidly from 1.6 percent in 1994 to 5.5 percent in 2014. A questionnaire survey conducted on people who have resided in both Japan and the United States shows that a large number of services in Japan are regarded as lower in price for the For example, see Haltmaier (2012). quality (Chart 6). Japan's labor productivity appears to have declined through the various channels mentioned earlier. It is often pointed out that labor productivity in Japan is lower than in other advanced economies. For example, Jorgenson et al. (2016) made a comparison between Japan and the United States in the levels of labor productivity, showing that productivity in Japan was around 40 percent lower than in the United States in 2012. However, factors that had lowered labor productivity are now being addressed. As supply-side constraints materialize in tandem with labor shortages, firms are proactively making fixed investment aimed at saving labor and increasing production capacity as well as addressing the training of employees. Firms are also streamlining inefficient business processes such as unrequested re-delivery services and late-night services where sales are low. According to the OECD, Japan's labor productivity, though remaining at a low level, has recently been improving at a relatively fast pace by catching up with that of other economies (Chart 7). II. Factors of a More Structural Nature Sluggish growth in wages and prices is also attributable to factors of a more structural nature. The following section will consider some examples, since these factors are also important from the viewpoint of the theme of today's session. A. Labor Force Participation of Women and the Elderly In Japan, where the population is rapidly aging and the birthrate is dropping sharply, the government and firms have been promoting the active participation of women and the elderly in the labor market. For example, steady progress has been made in increasing the number of nursery schools and nursing homes as well as moves to extend or abolish the mandatory retirement age (Chart 8). As a result, the number of women and the elderly participating in the labor force has been increasing. The aging of baby boomers has also contributed to the rise in the ratio of the elderly to the overall workforce. Since wages for women and the elderly have tended thus far to be relatively low, these changes provide firms facing labor shortages with low-cost labor, thereby easing upward pressure on wages (Chart 9). Besides, although most women used to engage in jobs with simple and routine tasks, an increasing number of talented women have shifted to more professional occupations, leading to an increase in productivity. It has been noted that the easing of labor market conditions is also brought about by the diminishing of slack in terms of quality. B. Future Anxiety A possible decline in long-term growth potential of the economy and anxiety over future income in anticipation, for example, of cuts in pensions, results in a rise in firms' and households' reserve savings. Such anxieties also exert downward pressure on wages and prices by restraining spending. The hardships that people suffered in past serious economic downturns might also be exacerbating their anxieties. Japanese firms lack confidence in their long-term profit growth and are thus cautious about raising wages -- particularly, base pay -- that can lead to a rise in fixed costs (Chart 10). In addition, an increasing number of households are anxious about their future income and life plans, with the number of such households remaining at a high level since a surge in the 1990s. Their propensity to save money seems to have exacerbated price competition among firms, bringing about downward pressure on prices (Chart 11). C. Technological Innovation Advances in information technology such as RPA and AI might also be contributing to a curb on growth in wages and prices. These technologies can contribute to improving the value added and raising sales through, for example, the development of new products and services; they are not simply a means to push down wages and prices. However, few Japanese firms nowadays consider these technologies to be the key to expanding business opportunities in the market; rather, most firms tend to regard them as a means to enhance operational efficiency and cut costs (Chart 12). This tendency seems to lead to the easing of labor market conditions and downward pressure on wages and prices. Still fresh in our minds are the announcements made in 2017 by each of Japan's three major banks of their decisions to reduce the work load that corresponds to a total of 33,000 employees within the next ten years through the use of information technology. The widespread use of smartphones and the expansion of e-commerce are also contributing to sluggish price rises. Consumers can now easily refer to and compare a broad range of information on prices at the press of a button, and purchase goods and services even from a distance. It seems that these changes have increased consumers' responsiveness to prices, consequently somewhat accelerating price competition among firms. D. Factors Specific to Particular Industries In some industries, downward pressure on wages and prices is brought about by specific factors. For example, although the medical and nursing care industries are expanding rapidly amid advanced population aging, service prices in these industries are controlled under the remuneration systems for medical treatment and nursing care. Thus, wage growth in these industries has been sluggish despite high demand in the labor force, the tightening of labor market conditions, and the remarkable increase in the number of employees (Chart 13). III. Framework of Monetary Policy As discussed thus far, it seems that both the reversal of hysteresis and the factors of a more structural nature have been constraining growth in wages and prices. With a focus on the reversal of hysteresis, which seems to be the more important factor for the time being, this is perhaps the place for a personal assessment of the current situation and what policy responses should be made to address the issue. A. Assessment of the Current Situation and Monetary Policy for the Time Being To reiterate the impact of hysteresis, the expansion of the supply side of the economy associated with the reversal of hysteresis seems to be restraining the upward pressure on prices exerted by an increase in demand. The active job openings-to-applicants ratio and the unemployment rate have been hovering at levels close to or above the peak level observed during the asset bubble period of the early 1990s, but the output gap has remained at a relatively low level. The aforementioned increase in labor input and labor productivity seems to have been easing the tightening of the output gap (Chart 14). However, there is no need to be unduly pessimistic about the situation. There are two reasons why. First, the expansion of the economy's supply capacity associated with the reversal of hysteresis will not last forever. There are limits to the extent of such changes as participation of discouraged workers in the labor market, conversion of involuntary non-regular employees into regular employees, and streamlining of inefficient business processes. The accumulation of (human) capital is also expected to decelerate as firms approach the frontiers of technology and skills through the course of the replacement of aging capital stock and improvements in the education and training of employees. From a somewhat longer-term perspective, the effects of a curb on growth in wages and prices through the expansion of supply capacity are expected to wane in due course. If a rising trend in prices strengthens, inflation is expected to accelerate gradually toward the 2 percent that the Bank is committed to achieving, accompanied by a rise in the public's inflation expectations brought about through the adaptive formation mechanism. Second, the reversal of hysteresis is itself a desirable change for people's lives. An increasing number of people are participating in the labor market in ways that meet their wishes, and firms are promoting a shift to more efficient and less wasteful working practices. Firms and employees are raising their competitiveness on the back of the introduction of new fixed investment and the development of employees' skills. Through these changes, the long-term growth potential of Japan's economy, which declined substantially in the past, is gradually strengthening again. Although price rises are being constrained at present, the momentum toward achieving the price stability target is being maintained. Furthermore, changes that will lead to improving people's lives and strengthening the economy's competitiveness are progressing steadily. It can be said that price rises are being restrained only temporarily as a side effect of such positive changes. In fact, amid the ongoing reversal of hysteresis, Japan's economy seems to be in a very favorable condition on the whole. It is essential, therefore, for the Bank to continue to conduct monetary policy under the current framework for the time being to maintain accommodative financial conditions, so that it can also continue to support the reversal of hysteresis. B. Future Policy Conduct in the Longer Run The next issue is a longer-term perspective; how monetary policy should be conducted in the future. The reversal of hysteresis might take some time. The supply side of Japan's economy may still be fairly subdued as a result of past successive serious economic downturns. Meanwhile, changes in the supply side of economy -- that is, the reversal of hysteresis -- proceed at a slow pace by nature. There is no consensus in academic or other circles regarding the extent to which and the time required for hysteresis to be eliminated. However, experts have argued that, under continued strong economic expansion, much of the hysteresis can be reversed, given time. 6 As for the outlook, the accommodative monetary policy might be maintained over a longer period, since the reversal of hysteresis could take a long time. In that case, it will be necessary to monitor the situation carefully to avoid any serious distortion in the economic and financial environment under prolonged accommodative financial conditions. The following two factors particularly warrant attention. First, it is necessary to keep a careful watch to prevent any significant supply-demand imbalance. Changes in the economy's supply capacity proceed at a relatively slow pace. An excessive increase in supply-side constraints under prolonged accommodative financial conditions is undesirable. If economic swings amplify significantly, there could be adverse effects, such as inefficient resource allocation. The Bank may then be rushed into tightening its monetary policy, possibly resulting in an interruption in the course of the reversal of hysteresis. In this situation, prices might rise in the short run, but this will not be stable over the long run. In realizing the reversal of hysteresis, focus should not be placed solely on tightening the output gap, but rather on maintaining moderately tight supply-demand conditions for as long as possible. Hall (2014) expresses the view that the extent to which and the time required for hysteresis to be dissipated differs for each element of the supply side of the economy, whether it is TFP, capital accumulation, unemployment, or the labor force participation rate. Kocherlakota (2014) -expressing agreement with Hall's view -- notes that much of the hysteresis can be reversed ultimately, referring to the fact that hysteresis resulting from the Great Depression was eliminated under vigorous demand during World War II. Second, it is also necessary to pay due attention to the stability of the financial system. In an environment where accommodative financial conditions have been maintained over a long period, the risk of an accumulation of financial imbalances will be heightened. According to the Bank's assessment presented in the April 2018 Financial System Report, although Japan's financial system as a whole is not showing any signs of overheating, some indicators, such as the lending attitudes of financial institutions, are very close to a state of overheating. Furthermore, if the low interest rate environment continues and downward pressure on financial institutions' profits becomes prolonged, the functioning of financial intermediation may be undermined. Under the "yield curve control," which the Bank adopts as one of its policy tools, as inflation expectations rise and the long-term growth potential of the economy strengthens in accordance with the reversal of hysteresis, monetary easing effects will be enhanced through a rise in the natural rate of interest and a decline in real interest rates. 7 When conducting monetary policy in the future, the Bank -- while taking account of the changes in the external environment -- should consider without prejudgment the most appropriate policy so as to avoid any serious distortion in the economic and financial environment. Upward pressure on wages and prices can be increased by appropriately addressing the factors of a more structural nature mentioned in Section II. In fact, wages for women are increasing steadily on the back of efforts by the government and firms to eliminate the wage gap between men and women. In addition, with the assumption of a further decline in population, the government is aiming to boost the number of foreign visitors and workers in order to raise the long-term growth potential of Japan's economy (Chart 15). It is also working toward developing IT-oriented human resources that are expected to create new value rather than simply raise efficiency and cut costs, so that IT-related technological innovation can be used for more creative and innovative economic activities. To raise the wages for nursing care workers, the government plans to make special and temporary Under the "yield curve control," the Bank facilitates the formation of short- and long-term interest rates that are considered most appropriate in light of the 2 percent price stability target. In the Bank's current guideline for market operations, the short-term policy interest rate is set at minus 0.1 percent and the target level for yields on 10-year Japanese government bonds is set at around 0 percent. revisions to regulations on the remuneration system for nursing care in fiscal 2019. 8 Even more of these proactive initiatives and efforts are expected to be made by the government and the private sector. Yet, as hysteresis and the factors of a more structural nature that have been discussed thus far cannot, by their very nature, be distinguished explicitly, monetary policy and structural policy should address these challenges interactively. The Cabinet decided that the projected tax gains accrued from the consumption tax hike scheduled to take place in October 2019 will in part be used to raise monthly wages for nursing care workers who have been in service for more than 10 years by an equivalent of 80 thousand yen on average. References Ball, Laurence M. 2014. "Long-Term Damage from the Great Recession in OECD Countries." NBER Working Paper no. 20185. ------. 2015. "Monetary Policy for a High-Pressure Economy." Center on Budget and Policy Priorities. March 30. Blanchflower, David G., and Andrew T. Levin. 2015. "Labor Market Slack and Monetary Policy." NBER Working Paper no. 21094. Cerra, Valerie, and Sweta Chaman Saxena. 2008. "Growth Dynamics: The Myth of Economic Recovery." American Economic Review 2008 98 (1): 439-457. Cœuré, Benoît. 2017. "Scars or Scratches? Hysteresis in the Euro Area," a speech delivered at the International Center for Monetary and Banking Studies, Geneva, May 19. Genda, Yuji, Ayako Kondo, and Souichi Ohta. 2010. "Long-Term Effects of a Recession at Labor Market Entry in Japan and the United States." The Journal of Human Resources Winter 2010 45 (1): 157-196. Hall, Robert E. 2014. "Quantifying the Lasting Harm to the U.S. Economy from the Financial Crisis." NBER Working Paper no. 20183. Haltmaier, Jane. 2012. "Do Recessions Affect Potential Output?" Board of Governors of the Federal Reserve System International Finance Discussion Papers no. 1066. Holzer, Harry J., Steven Raphael, and Michael A. Stoll. 2003. "Employers in the Boom: How Did the Hiring of Unskilled Workers Change During the 1990s?" IRP Discussion Paper no.1267-03. Hotchkiss, Julie L., and Robert E. Moore. 2018. "Some Like It Hot: Assessing Longer-Term Labor Market Benefits from a High-Pressure Economy." Atlanta Fed Working Paper no. 2018-1a. Howard, Greg, Robert Martin, and Beth Anne Wilson. 2011. "Are Recoveries from Banking and Financial Crises Really So Different?" Board of Governors of the Federal Reserve System International Finance Discussion Papers no. 1037. Jorgenson, Dale W., Koji Nomura, and Jon D. Samuels. 2016. "A Half Century of Trans-Pacific Competition: Price Level Indices and Productivity Gaps for Japanese and US Industries, 1955-2012." in The World Economy: Growth or Stagnation? edited by Jorgenson et al. 469-507. Cambridge University Press. Kroft, Kory, Fabian Lange, and Matthew J. Notowidigdo. 2012. "Duration Dependence and Labor Market Conditions: Theory and Evidence from a Field Experiment." NBER Working Paper no. 18387. Martin, Robert, Teyanna Munyan, and Beth Anne Wilson. 2015. "Potential Output and Recessions: Are We Fooling Ourselves?" Board of Governors of the Federal Reserve System International Finance Discussion Papers no. 1145. Narayana Kocherlakota. 2014. "Discussion of paper: 'Quantifying the Lasting Harm to the U.S. Economy from the Financial Crisis,'" a paper presented at the National Bureau of Economic Research Macroeconomics Conference. Reifschneider, Dave, William Wascher, and David Wilcox. 2013. "Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy." Board of Governors of the Federal Reserve System Finance and Economics Discussion Series no. 2013-77. Yellen, Janet L. 2014. "What the Federal Reserve Is Doing to Promote a Stronger Job Market," a speech delivered at the National Interagency Community Reinvestment Conference, Chicago, Illinois, March 14. ------. 2016. "Macroeconomics Research after the Crisis," a speech delivered at 60th annual economic conference sponsored by the Federal Reserve Bank of Boston, Boston, Massachusetts, October 14. Research and Statistics Department, Bank of Japan. 2018. A summary of the conference co-hosted by the Center for Advanced Research in Finance (CARF), the University of Tokyo, and the Research and Statistics Department, Bank of Japan, entitled "New Developments in Macroeconomic Analysis: Linkage between Business Cycle and Growth Trend," released on March 30 (available only in Japanese). Hysteresis and Sluggish Growth in Wages and Prices: The Case Study of Japan Presented at the 30th Villa Mondragone International Economic Seminar June 25, 2018 Makoto Sakurai Masahiko Kataoka Member of the Policy Board Director, Secretariat of the Policy Board Chart 1 Real GDP Growth 1985-1999 2000-2017 2007=100 1991=100 Japan US UK France Source: OECD. Chart 2 Labor Force Participation Rate Labor Force Participation Rate s.a., % Discouraged Workers 1.6 mil. 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 91 93 95 97 99 01 03 05 07 09 11 13 15 17 1 2 1 3 1 4 1 5 1 6 Note: Discouraged workers are people who are not seeking employment because they feel that they have no prospect of finding a suitable job. Source: Ministry of Health, Labour and Welfare. 1 7 Chart 3 Non-Regular Employment Non-Regular Employment Ratio1 % Non-Regular Employment due to Economic Reasons2 4.0 mil. 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 91 93 95 97 99 01 03 05 07 09 11 13 15 17 1 3 1 4 1 5 1 6 Notes: 1. The ratio of non-regular employment to total employment excluding executives of a company or corporation. 2. The number of those who work as non-regular employees due to the absence of firms that will employ them as regular employees. Source: Ministry of Health, Labour and Welfare. 1 7 Chart 4 Business Fixed Investment Business Fixed Investment Vintage Year tril. yen year 9.0 Small and medium-sized enterprises Depreciation expenses 8.0 Business fixed investment Large enterprises 7.0 6.0 5.0 4.0 3.0 Sources: Ministry of Finance; The Small and Medium Enterprise Agency. Chart 5 Education and Training Cost of Education and Training 2.0 thous. yen Implementation of Job Training % % 2.8 Monthly cost of education and training (left scale) 2.6 Percentage for total labor cost (right scale) 1.6 2.4 Off-the-Job training Non-regular employees Systematic OJT 2.2 1.2 2.0 1.8 0.8 1.6 1.4 0.4 Regular employees 1.2 1.0 0.0 Source: Ministry of Health, Labour and Welfare. Chart 6 Extravagant Services Services in Japan Higher/Lower in Price for the Quality (Comparison with the U.S.) Proportion of 24-hour Stores 6.0 % 1.10 1.05 5.0 Higher in price for the quality 1.00 4.0 0.95 3.0 0.90 2.0 0.85 0.80 1.0 0.0 Sources: Ministry of Economy, Trade and Industry; Japan Productivity Center. Lower in price for the quality Chart 7 Labor Productivity per Hour Worked Labor Productivity in 2017 US=100 Productivity Growth (2010-2017) 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Source: OECD. % Chart 8 Women and Elderly Labor Force Participation Capacity in Nursery Schools 3.0 mil. Mandatory Retirement Age % 2.7 2.4 2.1 1.8 1.5 05 06 07 08 09 10 11 12 13 14 15 16 17 05 06 07 08 09 10 11 12 13 14 15 16 17 65 and over Source: Ministry of Health, Labour and Welfare. 61 to 64 Chart 9 Employment and Wage Structure Share and Number of Employees 10 thous. Wage Structure thous. yen Difference Under 60 48.7% (3,133) 44.1% (2,881) -4.6%p (-252) 60 and over 9.8% 12.1% +2.3%p (+162) 35.6% (2,288) 35.6% (2,322) +0.0%p (+34) Men Under 60 Women Men 60 and over 5.9% 8.2% +2.4%p (+104) Women age group Source: Ministry of Health, Labour and Welfare. Chart 10 Business Confidence and Wage Increase Firms' Forecast on the Real Growth Rate for the Next 5 Years 4.0 % Reasons Firms Are Passing Over/ Undecided on Wage Increases % 3.5 3.0 2.5 1990s: 2.3% 2.0 2000s: 1.5% 1.5 90 92 94 96 98 00 02 04 06 08 10 12 14 16 Sources: Cabinet Office; The Japan Chamber of Commerce and Industry. Other Need to rein in increasing total labor costs due to higher number of employees 0.0 Wages already on par with other firms 0.5 Higher social insurance premiums increasing burden on firms 2010s: 1.2% Business conditions not improving 1.0 Uncertainty over Future Business environment and economic conditions Chart 11 Anxiety of Households Worries or Anxieties in Everyday Life % Causes of Worries or Anxieties (Changes between 1992 and 2017) % 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Source: Cabinet Office. Work and workplace relations Do not feel worried or anxious Family relations Future income and assets Current income and assets Family life events (higher education, employment, marriage, etc.) Own life events (higher education, employment, marriage, etc.) Feel worried or anxious Family health Own health Planning for post-retirement Chart 12 Purpose of Increasing IT Budgets Introduction of a private cloud Investment in mobile (%) 50 Regular system updates technology Prompt responses to changes in Introduction of IT to non-IT business processes markets and customers Use of new technologies/products/services Changes in business models using IT Greater business efficiency/cost reductions using IT Response to laws and regulations Enhanced development of products/services using IT Increasing sales Enhanced analysis of customer behavior and markets using IT Expansion of business operations/product lines Aggressive IT investment Increasing profits Expansion of size of the firm Defensive IT investment United States Japan Note: 85 Japanese firms and 156 U.S. firms answered to the questionnaire. Figures in the chart indicate the proportion of firms that selected each choice. Since this was a multiple-choice questionnaire, the sum of figures exceeds 100%. Source: JEITA. Chart 13 Demand for Labor and Wages Change in Wages Change in Number of Employees and New Job Openings mil. mil. Decrease (2002-2017, left scale) Increase (2002-2017, left scale) New job openings (in 2017, right scale) 3.5 2004=100 3.0 5.8 2.5 2.0 1.5 1.0 All industries Source: Ministry of Health, Labour and Welfare. Manufacturing Wholesale and retail trade Medical and nursing care Other Construction Accommodations, eating and drinking services 0.0 Manufacturing Wholesale and retail trade 0.5 Medical and nursing care 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Chart 14 Output Gap and Changes in Supply Capacity Output Gap and Labor Market Tightness 8.0 % points s.a., ratio Output gap (left scale) s.a., % 1.5 3.0 1.5 2.0 2.5 1.3 2.5 2.0 3.0 1.5 3.5 1.0 6.0 Active job openings-toapplicants ratio (right scale) 4.0 Unemployment rate (right scale, reverse axis) 2.0 Capital and Labor Input Growth (Contribution to the Potential Output) % points % points 1.6 Capital input (left scale) 1.2 Labor input (right scale) 0.8 1.1 0.0 4.0 0.5 0.7 4.5 0.0 5.0 -0.5 -2.0 -4.0 0.5 -6.0 -8.0 0.3 0.4 0.9 Sources: Ministry of Health, Labour and Welfare; Bank of Japan. 0.0 -0.4 5.5 -1.0 6.0 -1.5 -0.8 Chart 15 Structural Reform Wage Gap thous. yen Foreign Visitors and Workers % mil. mil. 0.8 0.6 0.4 0.2 0.0 Wages of women (left scale) Gender wage gap (right scale) Inbound foreign visitors (left scale) 1.4 1.2 Foreign workers (right scale) 1.0 05 06 07 08 09 10 11 12 13 14 15 16 17 Sources: Ministry of Health, Labour and Welfare; Ministry of Land, Infrastructure, Transport and Tourism.
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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, Ishikawa, 4 July 2018.
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July 4, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Ishikawa Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Kanazawa Branch. The Bank introduced quantitative and qualitative monetary easing -- or QQE for short -- in April 2013 with the aim of achieving the inflation target of 2 percent, and since then, has strengthened the QQE framework. As a result of the Bank's efforts, most economic indicators -- such as those of production, employment, investment, exports, and fiscal conditions -- have improved. Today, I would like to provide my views on the achievements thus far of the Bank's monetary policy measures as well as on some critical opinions regarding QQE, and then explain recent economic and financial developments as well as the path toward achieving the price stability target of 2 percent. I. The Achievements of Five Years of the Bank's Monetary Easing Policy April 2018 marked five full years since the Bank introduced bold monetary easing with its policy of QQE. For this reason, monetary policy over the past five years has been the subject of a large number of articles in newspapers and magazines assessing QQE from a variety of perspectives.1 Many of the assessments pointed out that the 2 percent price stability target had not been achieved and argued that the dangers associated with monetary easing had not been addressed. However, as I have highlighted repeatedly, monetary easing has led to a continued improvement in employment, to an increase in both real GDP growth and nominal GDP growth, and to a rise in the year-on-year inflation rate from negative into positive territory For example, such assessments were found in Fujita Tomoya, "Daikibo kanwa gonen, fukuramu 'fukusayō'," the Asahi Shimbun, April 4, 2018; and the 3-day series, Sakai Takayuki et al., "Shiren no saishidō," The Mainichi, February 17, 18, and 20, 2018 and the series focusing on monetary policy under the same title on April 10, 11, and 12, 2018. although the rate has not yet reached 2 percent. In my speech today, I would like to focus on how monetary easing has lifted productivity and, in a broader sense, has brought out people's potential in Japan. Improvement in Productivity Since the bold monetary easing policy was launched, productivity has been improving. This seems to conflict with standard textbook economic theory, which suggests that while monetary policy can influence real variables such as real GDP, production, and employment in the short run, in the long run it can only affect nominal variables such as nominal GDP, prices, and the exchange rate.2 So, why did Japan's productivity rise as a result of monetary policy even though this seems to run counter to economic theory? The reason generally given is that what economic theory actually focuses on is differences in productivity levels arising due to differences in productivity growth rates over the super long term. Looking at real purchasing power parity GDP per capita, which provides a broad indicator of differences in productivity across countries, the level between the poorest and richest countries may differ by a factor of more than 100. Of course, such a gap is not due to differences in monetary policy. Returning to the situation in Japan, however, if monetary policy had been well implemented, productivity might have grown, over a period of a decade or more, at 2 percent rather than 1 percent. Therefore, I would say one reason, first of all, is that in the short run capacity utilization rises. In times of recession, orders fall and factories will decrease output. However, since labor cannot simply be laid off, labor productivity will decline. The opposite occurs during an economic expansion. For details, see Nicholas G. Mankiw, Mankyū keizaigaku II makuro-hen, 3rd ed., trans. Adachi Hideyuki, Ishikawa Jota, Ogawa Eiji, Jinushi Toshiki, Chuma Hiroyuki, and Yanagawa Takashi (Tokyo: Toyo Keizai Inc., 2014), 374, 397. Originally published as Principles of Economics, 6th ed. (Mason, Ohio: South-Western Cengage Learning, 2012), 650, 665. According to Mankiw, in the long run, changes in the amount of money have important effects on nominal variables such as price levels, but only negligible effects on real variables such as real GDP. He adds that, although monetary policy is neutral in the long run (i.e. it does not have an effect on real variables), it has profound effects on real variables in the short run. Another reason is a reduction in low-productivity work in an economic environment where monetary policy is producing its intended effects. In times of recession, sales fall, and stores will try to increase demand, even if only a little, by extending their business hours. The opposite occurs during an economic upturn. If there are labor shortages, restaurants that used to stay open until midnight, for example, will start to close early. If they open only during the busiest times during the day and in the evening, labor productivity will increase. Furthermore, over the long term, there is the issue of hysteresis effects.3 In a recession, firms reduce their investment, including that in employment and research and development (R&D). The unemployed do not have the chance to accumulate work experience. For example, many young people of the generation that entered the labor market during the so-called "employment ice age" were unable to gain work experience. When the economy is in recession, firms also reduce investment in training and human resource development. The reduction of investment, especially in R&D, results in a decline in productivity for a prolonged period. Reversing these developments takes quite a while. In fact, it may be difficult to ever make up lost ground. Young people who were caught up in the "employment ice age" and lost out in on-the-job training opportunities, especially from the mid-1990s to the mid-2000s and following the global financial crisis in 2008, may struggle to make up ground. Moreover, many of these people receiving low incomes have been unable to pay sufficient taxes and social security contributions, possibly contributing to a deterioration in fiscal conditions both at present and in the future. This impact is long lasting. While it is difficult to estimate exactly how large the impact is, it is certain to be considerable, judging by the increase in the share of non-regular employment during this period and the wage difference between regular and non-regular employees. All of this means that as the economy expands due to monetary easing policy, the negative hysteresis effects of the past should be mitigated and productivity should rise. Nakano Akihiro and Kato Ryo, "'Chōki teitai' ron o meguru saikin no giron: 'Rireki kōka' o chūshin ni," Bank of Japan Review, no. 17-J-2, March 2017, https://www.boj.or.jp/research /wps_rev/rev_2017/data/rev17j02.pdf. Chart 1 and the accompanying table provide a comparison of estimates by the Organisation for Economic Co-operation and Development (OECD) for labor productivity and real purchasing power parity GDP per hour worked for the Group of Seven (G-7) countries. Chart 1 Productivity of Major Economies U.S. dollars as of 2010 Japan United States United Kingdom Germany France Italy Canada Introduction of QE End of QE Introduction of QQE CY Note: Productivity is represented by real GDP per hour worked, converted by purchasing power parity exchange rates in 2010. Source: OECD, "Level of GDP per capita and productivity." Average Growth Rate of Productivity (%) Period Japan* United States* United Kingdom Germany France 20121.0 0.4 0.5 0.9 0.8 20020.9 1.6 0.9 0.9 0.5 19921.5 1.7 1.6 1.5 1.2 *The data for the period 2012 through 2016 are used instead of the data for 2012 through 2017. Italy Canada 0.2 1.2 0.0 0.8 0.7 1.3 The chart and table show that from 2012 to 2017, Japan, together with Canada, registered average annual productivity growth of 1.0 percent, the highest among the G-7 countries and hence higher even than the United States. Moreover, from a long-term perspective, Japan's average labor productivity growth rate since 2012 is even slightly higher than the average of 0.9 percent in the preceding decade from 2002 to 2012. Thus, while some might argue that Japan's productivity growth following the introduction of QQE has been modest, it has actually been high considering how low it had been by international comparison. Therefore, while Japan also faced the global financial crisis in 2008, which pushed down its productivity growth, I think it would be fair to say that productivity growth in Japan has been relatively high by international comparison. However, using labor productivity for comparison may be misleading. The reason is that firms tend to hire the most productive people first. Therefore, one would expect countries with a high unemployment rate to enjoy higher productivity, and this pattern tends to be borne out in practice. Productivity in both Italy and France is higher than in Japan, but the unemployment rate in those two countries is 11.3 percent and 9.4 percent, respectively. 4 However, when the unemployment rate is high, there are people who cannot work although they want to, which is unfortunate. Obviously, a better situation is one where the unemployment rate is low and all the people who want to work can work. Therefore, I thought it would be useful to look at real purchasing power parity GDP per working-age person. This should reduce the distortion introduced by focusing on labor productivity, since this indicator is higher when those who want to work do work, and lower when they do not work. In this context, it is worth quoting Dr. Osamu Shimomura, who was the brains behind the period of high economic growth achieved under Prime Minister Hayato Ikeda. In 1968, exactly 50 years ago, he said: "Why are we making such effort and putting up with such hardship to pursue economic growth? More than anything, we want to derive satisfaction from life and work. And isn't the greatest satisfaction in life being able to fully demonstrate one's abilities? We should pursue a society that provides such opportunities to all citizens. If we compare society today and society a hundred years ago, isn't the fundamental difference that, today, finally, a large number of citizens are gradually being provided with the opportunity to take advantage of their talents in one way or another?"5 I am not saying that simply raising the employment rate is the same as the ideals expressed by Dr. Shimomura. The figures are for 2017 and are taken from the World Economic Outlook Database April 2018, available on the website of the International Monetary Fund (IMF): https://www.imf.org/external /pubs/ft/weo/2018/01/weodata/index.aspx. Kamikubo Satoshi, Hyōden, Nihon no keizai shisō, Shimomura Osamu, 'Nihon keizaigaku' no jissensha (Tokyo: Nihon Keizai Hyouronsha Ltd., 2008), 227. However, I believe that providing people with the opportunity to work is the starting point for people to be able to fully demonstrate their abilities. This can also be said, for example, with regard to women's entry into the labor market. According to statistics released by the OECD, the labor force participation rate of women aged between 25 and 54 in Japan was 75.3 percent in 2017; this figure is higher than that for the United States -- which is 72.1 percent -- and the average of the G-7 countries -- which is 73.5 percent, with France at 75.2 percent, Germany at 80.0 percent, and the United Kingdom at 78.1 percent. Currently, the issue surrounding working women in Japan is not the labor force participation rate itself, but the scarcity of opportunities for women to develop their career at work, given that many women work as part-timers or non-regular employees. However, without entry into the labor market in the first place, women cannot create career plans. I believe that, as the number of working women increases, more women will become regular employees, enabling them to develop their career; in fact, in 2016, the ratio of women in managerial positions in establishments with 30 employees or more in Japan increased, according to the fiscal 2016 Basic Survey of Gender Equality in Employment Management (available only in Japanese) released on July 28, 2017 by the Ministry of Health, Labour and Welfare. Chart 2 shows real purchasing power parity GDP per working-age person. As can be seen in the chart and the accompanying table, since the introduction of QQE, Japan's growth rate has been the highest among the G-7 countries, and has also been notably higher than during the preceding decade from 2002 to 2012. This means that those who want to work are increasingly able to work. Chart 2 Real PPP GDP per Working-Age Person of Major Economies 90,000 International dollars as of 2011 Introduction of QE End of QE Introduction of QQE Japan United States 80,000 United Kingdom Germany 70,000 France Italy 60,000 Canada 50,000 40,000 CY 30,000 Note: Annual figures for working-age person are obtained by linear interpolation of data for every five years. Figures for Germany through 1990 are those for West Germany. Real GDP is converted by purchasing power parity (international dollars as of 2011). Sources: IMF, "World Economic Outlook Database"; United Nations, "World Population Prospects: 2017 Revision." Average Growth Rate of the Real PPP GDP per Working-Age Person (%) United States United Kingdom Period Japan Germany France Italy Canada 2.3 1.7 2.1 1.6 1.2 0.9 1.7 1.4 0.8 0.6 1.4 0.8 -0.1 0.8 1.2 1.5 1.6 1.4 1.3 0.8 1.5 Of course, there are people who say this level of productivity growth in Japan is not ideal and that productivity should be raised further by pushing ahead with the growth strategy and structural reforms. However, people saying this do not seem to clearly explain what kind of policy measures will produce how much productivity growth. To avoid any misunderstandings, let me state that I strongly agree with structural reforms. All I am saying is that it is good to conduct both monetary easing policy and structural reforms. In addition to productivity, improvements can also be seen in many other indicators such as production, employment, the unemployment rate, investment, exports, and the fiscal situation; moreover, perceptions that the economy is recovering, the income distribution, and women's entry into the labor market provide further indications of improvement.6 II. Some Counterarguments to Critical Opinions on the Bank's Monetary Policy As mentioned above, monetary policy has been clearly having an effect, but for some reason, objections to the Bank's current policy persist. Among the critics are some who argue that QQE is like the Battle of Imphal during the Second World War and we should withdraw immediately. 7 The Battle of Imphal took place from March 1944 to early July and involved the Japanese army advancing from Burma with the aim of capturing the city of Imphal in northeast India. The battle was an abject failure entailing enormous sacrifice and is often cited as synonymous with a reckless strategy. There was no food along the way, resulting in many deaths from starvation, there were attacks by enemy fighter aircraft, and many soldiers contracted malaria, so that of the 100,000 Japanese troops, 30,000 died in battle, while 20,000 were sent back due to injury or disease. Of the remaining 50,000 troops, more than half fell ill, and the Japanese army suffered a devastating defeat.8 In contrast with such disastrous consequences, QQE is clearly having a positive impact, with most economic indicators improving. Therefore, I think this analogy between QQE and the Japanese army's Battle of Imphal is simply inaccurate. What is Dialogue with the Market? In this context, it is often said that dialogue with the market is important for the conduct of monetary policy. We must also engage with people who are critical of QQE. I suppose dialogue normally helps to seek out the truth or discover what the vital interests of the other Regarding improvements in these indicators, also see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Fukushima," Bank of Japan, November 2017. See, for example, Kato Izuru, "Sensō makki to kasanaru Nichigin tettei kōsen, Kuroda sōsai ga nerau wa 'ichigeki kōwa' ka," Diamond online, March 4, 2016, https://diamond.jp/articles/-/87079. Kumano Hideo, "Deguchi no meiro, kin'yū seisaku o tou 6, Inpāru sakusen kara hayaku tettai o," Shūkan Ekonomisuto, November 14, 2017, https://www.weekly-economist.com/20171114bojexit6. Tobe Ryoichi et al., Shippai no honshitsu, Nihongun no soshikiron-teki kenkyū (Tokyo: Chuokoron-shinsha, 1991), 141-177. party are and to what extent one is able to make compromises oneself. However, dialogue with the market is different from regular dialogue. There is no such thing as an abstract market; rather, the market consists of a collection of different stakeholders, who, moreover, do not necessarily seek the truth. In addition, because the market comprises a variety of stakeholders with different interests, it would be misleading to say that something is or is not in the interest of the market as a whole. If the Bank were to implement policy measures without listening to the views of stakeholders, it could become complacent and create unnecessary confusion; at the same time, this does not mean that the Bank will or should do everything stakeholders say. For instance, sometimes it is said that the market is calling for an early rise in interest rates. However, if the Bank were to indeed raise interest rates, bond and stock prices would decline and the yen would appreciate, leading to a deterioration in firms' profits, credit costs would increase, and financial institutions would suffer substantial damage. Moreover, even if short-term interest rates were raised, long-term interest rates would not necessarily rise, so that the spread between short-term and long-term interest rates might actually decline. This is currently happening in the United States and has happened in Japan since 2006.9 The reason many market participants think that the yield curve will steepen and hence the term spread will increase when the Bank raises interest rates is probably that they expect the opposite to happen of the flattening of the yield curve seen at the time the Bank introduced the negative interest rate policy on January 29, 2016. However, looking at the facts, we find that the yield curve often tends to flatten when monetary policy is tightened. Chart 3 shows the uncollateralized overnight call rate and long-term interest rates -- represented by 10-year Japanese government bond yields -- from 2000 to the present. The chart shows that when policy was tightened on August 11, 2000 (termination of the zero interest rate policy; For instance, Reuters reported that the Federal Reserve Bank of St. Louis President James Bullard said: "We are at some risk of a yield curve inversion, later this year, early 2019." See Gertrude Chavez-Dreyfuss, "Fed's Bullard says U.S. yield curve might invert by early 2019," Reuters, May 15, 2018, https://www.reuters.com/article/usa-fed-bullard-yieldcurve/update-1-feds-bullard-says-us -yield-curve-might-invert-by-early-2019-idUSL2N1SL10U. This, naturally, is not certain to happen, but has happened before. overnight call rate of around 0.25 percent set as the guideline for money market operations), on July 14, 2006 (termination of zero interest rates; policy rate hike from 0 percent to around 0.25 percent), and on February 21, 2007 (policy rate hike from around 0.25 percent to around 0.5 percent), the yield curve flattened, that is, the term spread declined. The exception is the period around the time when the Bank reverted from its policy of quantitative easing to conventional interest rate policy on March 9, 2006, shifting its operating target of money market operations from the outstanding balance of current accounts at the Bank at around 30-35 trillion yen to the uncollateralized overnight call rate to remain at effectively 0 percent; following the policy change, the term spread increased. Chart 3 Short-Term and Long-Term Interest Rates 2.5 % 2.0 1.5 1.0 0.5 0.0 -0.5 CY 00 01 02 03 04 Monetary easing Uncollateralized overnight call rates 11 12 13 14 15 Monetary tightening Yields on 10-year JGBs Source: Bloomberg. On the other hand, when monetary policy was eased, the yield curve sometimes flattened and sometimes steepened; specifically, when the main operating target for money market operations was changed on March 19, 2001 from an uncollateralized overnight call rate of around 0.15 percent to the outstanding balance of the current accounts at the Bank at around 5 trillion yen; when the outstanding balance of the current accounts at the Bank was raised on December 19, 2001 from above 6 trillion yen to around 10-15 trillion yen; when the upper limit of the target balance of the Bank's current accounts was raised on October 10, 2003 so that the target balance would change from around 27-30 trillion yen to around 27-32 trillion yen; when the Bank's target for the uncollateralized overnight call rate was lowered on October 31, 2008 from around 0.5 percent to around 0.3 percent; and when the Bank's target for the uncollateralized overnight call rate was lowered on October 5, 2010 from around 0.1 percent to around 0-0.1 percent. In particular, when QQE was introduced on April 4, 2013 -- when the Bank's main operating target for money market operations changed from the uncollateralized overnight call rate of around 0-0.1percent to the monetary base so that the monetary base would increase at an annual pace of about 60-70 trillion yen -- the yield curve steepened as a result of monetary easing. The reason probably is that monetary easing was recognized as having a positive effect on inflation expectations and economic activity. Thus, whether the yield curve flattens or steepens when short-term interest rates are raised depends on the economic situation as well as the market's view of monetary policy at the time. It is therefore wrong to think that if short-term interest rates are raised, the yield curve will steepen. I think that what market participants would like from dialogue with the central bank is for the central bank to provide a clear outlook for the future course of monetary policy. However, since the central bank conducts policy referring to price and economic indicators, that is, based on data, it is generally not possible to chart the future course of monetary policy by announcing in advance that it will raise interest rates at certain points in time in steps of, say, 25 basis points regardless of economic conditions.10 That said, if future economic indicators could be predicted with some certainty, it might be possible to outline future policy accordingly. I think the Federal Reserve believes that the U.S. economy is in such a situation. In the United States, where inflation expectations are anchored at 2 percent, it is possible to predict future price developments more reliably, so that the Federal Reserve can chart the course of future policy. Yet, even in the United States, there has been criticism that the projections of monetary policy presented in so-called "dot plots" often turn out to be In "Central Banking and the Global Economy" (a speech given at an international symposium entitled "Central Banking & Monetary Policy: The Global Economy & Japan" hosted by the Hitotsubashi Graduate School of Commerce and Management at Hitotsubashi Hall on May 12, 2017), the former governor of the Bank of Israel, Mr. Jacob Frenkel, emphasized that central bank operations must be conducted based on data, not on a certain timeframe. inaccurate, causing unnecessary confusion. 11 In Japan's current situation, where inflation expectations are not anchored at 2 percent, it would likely be even more difficult to chart future policy in advance. In sum, while the central bank should communicate with the market, its focus should be on conducting policies aimed at maintaining price stability, the sound development of the national economy, and the stability of the financial system. The Bank's Monetary Easing Policy and the Profitability of Private Banks One subgroup of market participants is bank managers, and many of them have argued that the low interest rates brought about by QQE have depressed banks' profits, and that this is a side effect of QQE. They say that QQE undermines their business model, which is based on the premise that interest rates are positive and consists of profiting from the difference between high long-term interest rates and low short-term interest rates. This is equivalent to saying that unless purchasing and selling prices are somehow preordained, you cannot conduct business. However, every business derives its profits from the difference between ever-changing costs and sales proceeds. The reason why conditions for private banks are difficult is that there are few borrowers. From a macroeconomic perspective, Japanese firms have sufficient cash and deposits at private banks, so they do not need to borrow funds from them. According to the Bank's Flow of Funds Accounts, as of end-March 2018, firms in Japan had cash and deposits of 261 trillion yen. Relative to the demand for funds, there is a glut of supply. Bloomberg reported that Federal Reserve Bank of St. Louis President James Bullard in relation to the dot plots observed that "[t]he whole idea that you're naming the number of rate hikes way out into the future when you don't know what the data are going to be is something we should get out of the business of doing." See Christopher Condon and Brendan Murray, "Bullard Laments Fed Dot Plot, Yearns for Greenspan's Opacity," Bloomberg, May 17, 2018, https://www.bloomberg.com /news/articles/2018-05-16/bullard-laments-fed-dot-plot-and-yearns-for-greenspan-s-opacity. Then Federal Reserve Bank of San Francisco President, now Federal Reserve Bank of New York President John Williams, commented that "the time is approaching to phase out" forward guidance, which communicates the intended future path of the federal funds rate. See Jeanna Smialek, "Williams Says Fed's Era of Market Hand-Holding Is Nearing an End," Bloomberg, May 17, 2018, https://www.bloomberg.com/news/articles/2018-05-16/williams-says-fed-s-era-of-market-hand -holding-nearing-an-end?in_source=video_page. In addition, as mentioned earlier, if the Bank were to indeed raise interest rates, bond and stock prices would decline and the yen would appreciate, leading to a deterioration in firms' profits, and credit costs would increase, so that private banks would suffer substantial damage. Also, we do not know whether the yield curve would steepen if short-term interest rates were raised. Meanwhile, another argument is that if monetary easing continues, not only the financial situation of private banks but also that of the Bank of Japan would deteriorate, leading to serious problems. However, this is not the case. Because I have already talked about this on another occasion, I will not discuss it here today.12 Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Fukushima," Bank of Japan, November 2017. III. Recent Economic Developments and Outlook for Prices So far, I have talked about the long-term economic situation. I would now like to turn to the more short-term situation. Charts 4 and 5 present key economic indicators. Almost all the indicators -- production, investment, exports, employment, wages, and employee income, which is obtained by multiplying wages by employment -- have improved over the years. Some of the indicators were sluggish following the consumption tax hike in April 2014 and thereafter, particularly the period from the second half of 2014 to the first half of 2016, when global trade volume was sluggish. Some of the indicators temporarily contracted at the turn of this year, but the overall upward trend has continued. Chart 4 Production, Investment, Exports, and World Trade Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 s.a., CY 2012 = 100 Introduction of QQE with Yield Curve Control Sep. 2016 └ └ └ Industrial production Aggregate supply of capital goods └ └ └ World trade volume Real exports └ 2018 Sources: Ministry of Economy, Trade and Industry, "Indices of Industrial Production," "Indices of Industrial Domestic Shipments and Imports"; CPB Netherlands Bureau for Economic Policy Analysis, "CPB World Trade Monitor"; Bank of Japan, "Developments in Real Exports and Real Imports." Chart 5 Employment, Income, and Consumption Inauguration Introduction Consumption Expansion Introduction of Introduction of of the second of QQE tax hike of QQE QQE with a Negative QQE with Yield Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Curve Control Dec. 2012 Jan. 2016 Sep. 2016 s.a., CY 2012 = 100 % 5.0 4.5 4.0 3.5 3.0 2.5 2.0 └ └ └ └ └ └ 2018 Number of regular employees Consumption activity index (travel balance adjusted, real) Real wages Real employee income The ratio of real consumption to real employee income Unemployment rate (right scale) Note: Real employee income is calculated as the number of regular employees multiplied by real wages which is the total cash earnings deflated by the CPI (all items less imputed rent). The ratio of real consumption to real employee income is calculated as the comsumption activity index (travel balance adjusted, real) divided by real employee income. Sources: Ministry of Health, Labour and Welfare, "Monthly Labour Survey"; Ministry of Internal Affairs and Communications, "Consumption Price Index," "Labour Force Survey"; Bank of Japan, "Consumption Activity Index." └ Further, Chart 5 looks at employment, wages, employee income, and consumption. The reason why real wages has not increased is that the number of non-regular workers working short hours has increased. In terms of employment and real employee income, the consumption tax hike only had an impact in fiscal 2014. Apart from that, these indicators have grown more or less steadily except for the temporary slowdown seen at the turn of 2018. The unemployment rate has also steadily declined. Among these indicators, the one showing the weakest improvement is real consumption. Consumption as measured by the consumption activity index has not yet returned to the peak registered before the spike in demand due to the frontloading of purchases prior to the consumption tax hike. The average of the most recent three months, the February-April period of 2018, is still below the average of the October-December quarter of 2013, the quarter before the demand spike prior to the consumption tax hike. This is a bit strange given that real employee income, on which consumption expenditure rests, has steadily increased, except for the fall at the start of 2018. Although the ratio of real consumption to real employee income has been on a declining trend, it is difficult to imagine that this ratio will continue to decline, so that consumption can be expected to recover in the future. Another debate has focused on concerns about financial imbalances. Certainly, as seen in Chart 6, asset prices have been rising, albeit with some fluctuations, amid economic growth. While people who are worried about the side effects of monetary easing seem to regard this as an indication of financial imbalances, I think these increases in asset prices can hardly be called a bubble. Chart 6 Stock Prices and Price -Earnings Ratio 3,500 3,000 pts Stock Prices pts TOPIX S&P500 EURO STOXX (right scale) Price-Earnings Ratio 450 35 400 30 2,500 350 25 2,000 300 20 1,500 250 15 1,000 200 10 CY 08 09 10 11 12 13 14 15 16 17 18 times TOPIX S&P500 EURO STOXX CY 08 09 10 11 12 13 14 15 16 17 18 Sources: Bloomberg; T homson Reuters. The chart shows both stock prices and price-earnings ratios in Japan, the United States, and the euro area. The rise in stock prices in Japan is nowhere near as pronounced as in the United States, and the price-earnings ratio has not increased much, hovering at about 14. Moreover, taking into account the Bank's April 2018 Financial System Report, it can be judged that no major imbalances have built up in asset markets as a whole, although some indicators such as stock prices, the real estate loans to GDP ratio, and the diffusion index of lending attitudes of financial institutions have recently been close to the upper threshold of their trend ranges reflecting the rapid pace of increase in these indicators.13 Needless to say, it is essential that the Bank continues to constantly monitor for signs of financial imbalances. Path toward Achieving the Price Stability Target of 2 Percent I mentioned earlier that consumption has been weak, and I would now like to turn to prices, which have also been weak. However, if the economic recovery continues and employment tightens, prices should rise eventually. In this context, one often hears the question why prices are not rising even though the unemployment rate has fallen to around 2.5 percent, well below 3.5 percent, which until recently was widely regarded as the structural unemployment rate. My answer to this question is simple: the decline in the unemployment rate is insufficient. Moreover, it would be completely wrong to think that the structural unemployment rate is still the previously estimated 3.5 percent.14 Chart 7 shows the Phillips curve for Japan, which depicts the relationship between the inflation rate and the unemployment rate. The regression lines represent this relationship for each of the following periods: from January 1983 through March 2013, from January 1983 through December 1995, and from January 1996 through March 2013. All of these regression lines show that, unless the unemployment rate falls below 2.5 percent or so, the Bank of Japan, Financial System Report, April 2018: 30-32, https://www.boj.or.jp/en/research /brp/fsr/data/fsr180419a.pdf. See footnote 19 in Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Fukushima," Bank of Japan, November 2017. Another issue is output gap estimates. While estimates by the Bank's Research and Statistics Department and the Cabinet Office each suggest that Japan's output gap is positive, the IMF's estimates for Japan are negative, even for 2017, according to the World Economic Outlook Database April 2018, available on the IMF website: https://www.imf.org/external/pubs/ft/weo/2018/01/weodata/index.aspx. Chart 7 Phillips Curve CPI (less fresh food and energy), y/y % chg. A: 1983/1-2013/3 y = -1.0455x + 4.4274 R² = 0.7766 B: 1983/1-1995/12 y = -1.9918x + 6.8934 R² = 0.5127 B C: 1996/1-2013/3 y = -0.6609x + 2.6773 R² = 0.4591 C -1 1983/1-2013/3 2013/4-2018/5 A -2 Unemployment rate, % % Introduction of consumption tax Apr. 1989 Consumption tax hike Apr. 1997 Consumption tax hike Apr. 2014 -1 Unemployment rate -2 CPI (less fresh food and energy, y/y chg.) -3 CY Note: The CPI figures are adjusted for changes in the consumption tax rate. Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Formula Estimate of the unemployment rate corresponding to 2% (%) Avg. growth rate of the observed CPI (annualized, %) A CPI = -1.05 × unemployment rate + 4.43 2.3 0.5 B CPI = -1.99 × unemployment rate + 6.89 2.5 1.6 C CPI = -0.66 × unemployment rate + 2.68 1.0 -0.3 inflation rate will not reach 2 percent. For instance, looking at the period from January 1983 through December 1995, the inflation rate in terms of the consumer price index (CPI) during that period was 1.6 percent, and the regression line for that period indicates that for inflation to rise to 2 percent, the unemployment rate would need to fall to around 2.5 percent. Thus, as the regression line B in chart 7 suggests, if inflation rates rise continuously at about 1.5 percent and the unemployment rate is at 2.5 percent, then 2 percent inflation will be achieved. In order to achieve 2 percent inflation, the inflation rate, which was 0.3 percent for May 2018, would have to rise to around 1.6 percent, while the unemployment rate, which was 2.2 percent for May 2018, would have to be maintained at around 2.5 percent. Another issue is that the unemployment rate necessary to push up inflation has become even lower, since there is room for a further increase in the employment rate. According to the May 2018 Labour Force Survey released by the Ministry of Internal Affairs and Communications, the number of employees increased by as many as 1.51 million from a year earlier, although the number of the unemployed was only 1.58 million. Moreover, I hear that, due to continued labor shortages, labor in low-productivity sectors and excess labor at firms seems to be shifting to other industries or firms. This shift pushes up labor supply in real terms. Thus, if productivity rises, an increase in inflation is delayed.15 Disregarding these factors and assuming that there is no labor slack by simply using the employment rate and the labor force participation rate of men aged between 25 and 54 in 1992 -- when the employment rate among this group was at a historical high -- the unemployment rate for 2017 is estimated to be 2.3 percent. The unemployment rate in 1992 stood at 2.2 percent, but the proportion of young people was higher at that time. Given that the unemployment rate among the young is usually higher, and that among the middle-aged is usually lower, the estimated unemployment rate for 1992 is 1.9 percent if it is adjusted based on the demographic structure in 2017. The calculations imply that in order to achieve the level of inflation seen in 1992, which was 2.2 percent in terms of the CPI for all items less fresh food and energy, the The same idea is also provided in "II. Price Developments and their Outlook," Section II in Hiroshi Nakaso, "Japan's Economy and Monetary Policy: Speech at a Meeting with Business Leaders in Hiroshima," Bank of Japan, July 2017. unemployment rate has to remain at its May 2018 level of 2.2 percent. While I am not saying that I believe that these estimates are fully accurate, I do think that the current unemployment rate needs to fall further in order to achieve the price stability target of 2 percent. Just to be sure, I would like to add that I am not saying that monetary easing should continue until the unemployment rate has fallen to 2 percent. In conducting monetary policy, the Bank should pay close attention to price developments, and past observations on the link between prices and the unemployment rate should be regarded merely as supplementary information to help with making appropriate monetary policy decisions. Since there is room for further increases in employment and production, the Bank needs to continue with the current monetary policy measures in order to achieve the price stability target of 2 percent. Needless to say, it is essential that the Bank continues to constantly monitor for signs of financial imbalances, but for now, the likelihood of such imbalances is small. Now, I would like to briefly talk about the deletion of the description regarding when 2 percent inflation would be achieved in the Bank's April 2018 Outlook for Economic Developments and Prices (Outlook Report), since the deletion became the subject of debate among market participants. Specifically, the deleted description was that the timing "will likely be around fiscal 2019." However, the timing mentioned in the Outlook Report was merely a projection, and any changes in the projected timing were not automatically linked to any changes in policy, nor was its deletion. In my view, prices are influenced by a variety of factors; what is important is that the mechanism through which prices rise works well, and policy decisions should be made in line with developments in this mechanism. In other words, additional monetary easing might be necessary if inflation loses momentum, but otherwise the current policy should be maintained. Cognitive Dissonance with Respect to QQE I sometimes feel that the attitude of those who are opposed to QQE shows signs of what can be called "cognitive dissonance." Cognitive dissonance is, of course, a term from psychology that is also used in marketing and refers to the mental discomfort experienced by a person when new information contradicts their personal beliefs. In that case, many people attempt to reduce the discomfort by denying the new information. When confronted with information that the economy is actually improving despite their strong belief that QQE will not help the economy grow, these critics will try to reduce such dissonance by denying this information or by arguing that even though economic developments are favorable at the moment, they will definitely deteriorate in the future. For example, the argument that any future exit from monetary easing will cause major problems also tries to reduce discomfort by referring to future possibilities. Since such arguments focus not on the present but on the future, they allow these opponents of QQE to avoid facing such dissonance for the time being. Another confused psychological mindset is to cast doubt on the monetary easing measures themselves. In this mindset, bold monetary easing is risky, and such measures should not be taken. However, it seems to me that human beings may have had this kind of risk-averse mindset since ancient times. Mythological stories around the world, from every culture, describe the tragedy that befalls anyone who has the hubris to challenge the gods. You see this for example in the stories of the Tower of Babel, of Daedalus and Icarus, and of golems. Perhaps those critics who are most vocal in their critical opinions on QQE are afraid that the economic gods will vent their anger over QQE. And if it is not against the laws of the gods, perhaps opponents of QQE believe it is somehow going against the laws of nature. This reminds me of a famous play in kabuki -traditional Japanese theatre -- called Narukami Fudō Kitayama Zakura. One of the themes of this story is that the laws of nature should not be broken. In order to prevent evil Prince Hayakumo from succeeding to the throne, the Imperial Court in ancient Japan asked Saint Narukami to perform an occult rite so that the girl that the empress was pregnant with would be born as a boy. In exchange for his services, the court initially promised to build Narukami a temple, but the promise was suddenly withdrawn because of his violation of the laws of nature. However, is QQE a policy that violates the laws of nature? Perhaps the unshakeable critics of QQE believe that monetary policy does not belong within the human realm, but under the purview of a single omnipotent force. Asked whether it is right to pay the imperial tax to Caesar, Jesus once asked for confirmation that the coin used for paying the tax bore the image of Caesar and said: "So give back to Caesar what is Caesar's, and to God what is God's." Monetary policy without doubt falls within the human realm. And if it falls within the realm of humans, it should be discussed based on theory, facts, and evidence. Concluding Remarks As stated so far, the Bank's bold monetary easing measures have been producing their intended effects, leading to an improvement in production, employment, productivity, the unemployment rate, investment, exports, and fiscal conditions. Further indicators are perceptions that the economy is recovering, improvements in income distribution, and women's entry into the labor market. Although some people are critical of the Bank's monetary easing measures, their arguments are not supported by empirical evidence. If the Bank were to conduct monetary policy in the way they say it should, economic activity would deteriorate and markets would fall into turmoil. In its assessment of recent economic developments and monetary policy, the Bank concluded that it should continue with the current monetary easing with a view to achieving the price stability target of 2 percent, given that, for now, there is still room for an expansion in employment and that there are few signs of financial imbalances. Thank you for your attention.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kyoto, 2 August 2018.
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August 2, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kyoto Masayoshi Amamiya Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Before I begin my speech, I would like to extend my sincere condolences to the victims of the torrential rains last month and express my deepest sympathies to those who are suffering. Some areas, especially in the northern part of Kyoto Prefecture, continue to be severely affected and there is still much to be worried about. I am very honored to have the opportunity to exchange views with administrative, financial, and business leaders in Kyoto Prefecture today. 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 Kyoto Branch. At the Monetary Policy Meeting (MPM) two days ago, the Bank released its quarterly Outlook for Economic Activity and Prices (Outlook Report) containing the projections for Japan's economic activity and prices through fiscal 2020 and a detailed analysis on price developments. In addition, it strengthened the policy framework with a view to persistently continuing with the current powerful monetary easing. Today, I would like to explain the Bank's view on economic activity and prices as well as the new policy measures, while outlining the Outlook Report. I. Economic Developments in Japan Let me start with economic developments in Japan. Japan's economy has improved significantly over the past five years. The current economic recovery phase, which began in December 2012, has reached 66 consecutive months this May. If this recovery continues through January next year, it could overtake the longest post-war expansion of the economy so far, which lasted 73 months. Corporate profits have been at record high levels, and the labor market has been close to full employment, with the unemployment rate being in the range of 2.0-2.5 percent -- the lowest level in around 25 years (Chart 1). Confirming this situation by looking at the output gap, which represents the utilization of capital and labor, shows that it exceeded the long-term average of 0 percent around 2013, clearly turned positive in the second half of 2016, and since then has been widening further within positive territory (Chart 2). Turning to wages and prices, a base pay increase has been achieved for five consecutive years as a result of wage negotiations. In addition, the year-on-year rate of change in the consumer price index (CPI) excluding energy and fresh food has been on an uptrend for more than four and a half years since autumn 2013, and Japan's economy is no longer in deflation, in the sense of a sustained decline in prices. II. Price Developments Thus, Japan's economic activity and prices have improved steadily over the past five years. However, prices have continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and the Bank's price stability target of 2 percent in terms of the annual inflation rate has not yet been achieved. For this reason, in formulating the latest Outlook Report, the Bank focused on examining the reasons for these sluggish price developments and their outlook. In what follows, I would like to present the contents of the report and talk in more detail about the price situation in Japan. A. Why Is the Bank Aiming at 2 Percent Inflation? Before explaining the background to the continued relatively weak developments in prices, I will first talk about the reasons why the Bank is aiming at achieving the price stability target of 2 percent. I start with this topic because people often make comments such as "The price stability target of 2 percent is too high in the first place and it may not be necessary to aim at it forcibly," or "As long as the economy is growing, it would be better if prices do not rise." The fundamental mission of central banks in conducting monetary policy is to achieve price stability. Price stability is a situation that is neither deflationary nor inflationary -- in other words, prices neither rise nor fall -- and thus could mean that the year-on-year rate of change is 0 percent in numerical terms. However, the specific definition of price stability currently shared among advanced economies is that a slightly positive annual inflation rate, rather than a rate of 0 percent, would be desirable (Chart 3). The first reason is that the CPI -- the price statistics that many central banks refer to -- has a statistical tendency of demonstrating a slightly higher inflation rate than the actual one. While I will not explain this in detail, as it is somewhat technical, considering such statistical tendency, or upward bias, an appropriate figure for price stability in terms of the CPI is a slightly positive figure. The second reason for aiming at 2 percent inflation is the need to have a buffer for monetary policy. Central banks usually respond to inflation and deflation by raising or lowering interest rates. In the event of inflation, central banks can raise interest rates as much as necessary to suppress inflation. The reason for this is that there is no ceiling to interest rates. On the other hand, when we face deflation, there is a limit to the extent to which interest rates can be lowered. In recent years, a new approach employing negative interest rates has been developed, but it remains impossible to lower interest rates without limits. Deflation is a more troublesome phenomenon than inflation in the sense that central banks' ability to respond to the former is limited. Thus, it is desirable to have a buffer for monetary policy; that is, to secure a certain "margin" of positive inflation and positive interest rates in advance, so that central banks can take appropriate responses through monetary easing if the economy heads toward deflation. What these two reasons imply is that we should aim at a slightly positive inflation rate. However, there is no simple answer as to whether this should be 1 percent, 2 percent, or 3 percent. The important point is that central banks in major advanced economies more or less commonly define price stability as 2 percent. Of course, this is not based on a reckless argument that we should simply do what others are doing because there is no conclusive evidence as to what the inflation target should be. The reason why major advanced economies share the same inflation target and achieve a similar price situation is that, from a long-term perspective, this is likely to result in stable exchange rates. While exchange rates fluctuate due to a variety of factors in the short term, their trend over a longer term of 5 or 10 years reflects the difference in inflation between two countries. This is the concept of purchasing power parity. Therefore, aiming at the global standard of 2 percent inflation is very important in achieving stability in business management and in the economy as a whole through stable exchange rates. So far, I have provided three reasons why the Bank is aiming at the price stability target of 2 percent. However, I would like you to understand that the Bank does not think that it is enough simply to achieve 2 percent inflation. If only prices rise, real wages will decrease and economic activity will stagnate. As clearly stipulated in the Bank of Japan Act, the Bank shall implement monetary policy "aimed at achieving price stability, thereby contributing to the sound development of the national economy." Thus, the Bank aims at an economy in which prices rise moderately, as economic activity becomes more dynamic through increases in firms' sales and fixed investment as well as improvement in households' employment, wages, and consumption. An economy in which a virtuous cycle among prices, wages, and economic activity continues to operate would create a world in which the price stability target of 2 percent is achieved. B. Why Are Prices Sluggish? However, we are still halfway toward achieving the price stability target of 2 percent. The latest Outlook Report presents a fairly detailed analysis on reasons why prices have remained sluggish even though the economy has improved significantly. Today I would like to present the essence of the report. There are likely to be two main factors behind the fact that the pace of improvement in prices has remained moderate. One is that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households due to the experience of prolonged low growth and deflation. The other is that the large room to raise productivity and the technological progress in recent years have allowed firms to constrain price rises as much as possible. Let me explain these factors in detail by households' and firms' behaviors. First, it has been taking time for wage increases to fully take hold despite labor shortage. In particular, scheduled cash earnings of regular employees, who account for the majority of total employees, have been sluggish. The year-on-year rate of increase in such earnings over the past year has remained at around 0.5 percent (Chart 4). It is said that regular employees, whose wage levels are relatively high, have a strong tendency to place priority on the stability of employment over wage increases. Such tendency still seems to be persistent, reflecting the experience of severe employment adjustments under prolonged low growth. In addition, wage developments also are affected by growing diversity in terms of worker type. From a long-term perspective, an increase in labor participation by women and seniors in recent years is essential to cope with the declining trend in the working-age population, which is a challenge for Japan's economy. In the short term, however, this increase will ease labor shortage, thereby constraining wage increases. Second, the fact that households' tolerance of price rises has not been increasing clearly has been constraining a rise in inflation. According to the Bank's survey, following the introduction of quantitative and qualitative monetary easing (QQE) in 2013, the level of households' tolerance of price rises shifted upward in a favorable direction compared to past levels. However, the level has not risen further (Chart 5). This is likely to be attributable to the first reason mentioned earlier -- that is, it has been taking time for wage increases to fully take hold. Third, firms' cautious price-setting stance also has been constraining a rise in inflation. Although wages have been rising, albeit moderately, and commodity prices such as of crude oil have been on an uptrend, firms that are concerned about possibly losing customers due to price hikes have been making efforts to absorb upward pressure of costs on prices by increasing labor-saving investment and streamlining their business process. Firms have been enthusiastic about making software investment in sectors such as "construction," "retailing," and "accommodations, eating and drinking services," where labor shortage is acute, and many firms have offset a rise in labor costs by introducing self-checkout machines and automatic ordering system (Chart 6). These efforts by firms are likely made possible through the recent progress in information technology. So far, I have talked about firms' cautious wage- and price-setting stance as well as households' cautiousness toward price rises. Such mindset and behavior can be regarded as a kind of "social mode" in Japan that has been brought about by the experience of prolonged low growth and deflation, and it is likely to have been taking time to resolve this. In addition, the effects of intensifying competition among firms cannot be ignored. For example, retailers such as supermarkets have maintained their cautious price-setting stance, reflecting in part the expansion of online shopping (Chart 7). This is the so-called Amazon Effect, which is another example of rapid progress in information technology constraining a rise in inflation. C. Why Will Inflation Rise Going Forward? Although it is taking time for inflation to rise, some changes have been seen amid the continued improvement in the economic and employment conditions that I mentioned earlier. For example, moves to raise sales prices are starting to be observed recently at a wide range of firms, mainly in the services sector, such as dining-out (Chart 8). In addition, according to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan), the number of enterprises answering that the output prices have risen has been exceeding the number of those answering that such prices have fallen for the first time in a while. As the so-called baby boomers are reaching their 70s, labor market conditions are likely to tighten further and the pace of increase in wages of mainly part-time employees is expected to accelerate. As the effects of such moves of wage increases spread to regular employees' wages, this will lead to an increase in households' tolerance of price rises. When this happens, price rises by firms will be more easily accepted. While price developments are affected by various factors that I have explained so far, the factor that determines the underlying trend in prices is the aggregate supply-demand balance. As the output gap has been maintained within positive territory -- showing excess demand -- for a long time, in reflection of economic expansion, many of the aforementioned factors that have been constraining inflation will likely be resolved gradually. If that happens, another important factor that forms the underlying trend in prices is likely to change -- that is, people's perception of prices, which means inflation expectations in a broad sense, including households' tolerance of price rises and firms' price-setting strategies. The Bank assesses such factors that determine the underlying trend in prices by using the word "momentum." If you look up "momentum" in a dictionary, it is defined as "force" or "impetus," which imply a short period of time. However, as the objective of monetary policy is achieving price stability in the long term, the Bank assesses the "momentum" in terms of a somewhat longer time frame. Specifically, it makes a comprehensive judgment as to whether the momentum is maintained by examining the main factors that determine the underlying trend in prices, such as the output gap and medium- to long-term inflation expectations, while making use of various indicators and information. In the latest Outlook Report, the Bank projects that the year-on-year rates of change in the CPI (less fresh food) for fiscal 2018 through fiscal 2020 are likely to be 1.1 percent, 1.5 percent, and 1.6 percent, respectively (Chart 9). We are in a difficult situation in terms of achieving 2 percent inflation by fiscal 2020, as it is taking more time than expected for inflation to rise. Nevertheless, the momentum whereby an improvement in the output gap leads to an increase in actual inflation, and then a rise in inflation expectations, is maintained. It is of utmost importance to sustain such positive momentum by maintaining the output gap as long as possible within positive territory, and this is likely to be the most certain path toward achieving 2 percent inflation. III. The Bank's Conduct of Monetary Policy Next, I would like to explain the Bank's conduct of monetary policy including the measures decided at the MPM held two days ago. The Bank has been pursuing powerful monetary easing under the policy framework of "QQE with Yield Curve Control," aiming to achieve the price stability target of 2 percent (Chart 10). In order to achieve the price stability target at the earliest possible time, the Bank set the target level of 10-year Japanese government bond (JGB) yields at around zero percent, and has purchased large amount of JGBs so that the yield curve would be formed in line with the target. By conducting this operation, short- and long-term interest rates have been stable at low levels and lending rates as well as issuance rates for corporate bonds -- to which certain spreads are added in both cases -- also have remained at extremely low levels. The amount outstanding of bank lending has been increasing firmly. Thus, the current highly accommodative financial conditions, brought about by yield curve control, have largely contributed to an improvement in the output gap, stimulating firms' and households' spending activities. In addition, the Bank has purchased exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) with a view to exerting positive effects on economic activity and prices through lowering risk premia in the stock market. As I explained, following the discussion at the latest MPM, the Bank released its economic projections, which show that it will take more time than expected to achieve the price stability target of 2 percent. However, the momentum toward 2 percent inflation has been maintained. Accordingly, as for the conduct of monetary policy, the Bank judged it appropriate to persistently continue with the current powerful monetary easing, thereby maintaining the output gap as long as possible within positive territory, in order to make the momentum sustainable. During the discussion, we thought it necessary to address two challenges. The first is to firmly maintain confidence among the public regarding the Bank's current policy stance that aims at achieving the price stability target of 2 percent. The second is to strengthen the sustainability of the current powerful monetary easing so that the effects of monetary easing will not be reduced while taking care of such factors as the negative effects on financial markets, in a situation where monetary easing needs to be continued. In order to address these two challenges, the Bank decided to newly implement measures to strengthen the framework of powerful monetary easing. Today, within the limited time provided, I would like to introduce particularly important measures (Chart 11). First, the Bank decided to strengthen its commitment to achieving 2 percent inflation by introducing forward guidance for policy rates. You may not be familiar with the term, but forward guidance is a measure that guides the future policy path in order to strengthen market confidence and expectations toward monetary policy. At the latest MPM, the Bank publicly committed to "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." I would like to reiterate that, even though the projected timing of reaching 2 percent inflation has been delayed, the Bank will not reduce the degree of monetary easing. Second, the Bank decided to implement several measures to enhance the sustainability of "QQE with Yield Curve Control." For example, while the target level of 10-year JGB yields is around zero percent, as I mentioned earlier, the Bank made it clear that, under the target, the long-term yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. Recently, there is a growing concern in the JGB market that the market functioning has been deteriorating, with the long-term yields being somewhat stuck and the transaction volume being on a declining trend, although this can be regarded in a sense as the consequence of powerful monetary easing. In continuing with monetary easing, the Bank judged it necessary to allow the long-term yields to move upward and downward to some extent mainly depending on developments in economic activity and prices, thereby maintaining the market functioning so as not to create more concern. However, the target level of the long-term yields remains at around zero percent. In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately. The Bank does not expect the level of yields ratcheting up. In addition, as for ETF purchases, from the same aspect of enhancing the sustainability of the current monetary policy framework, the Bank made it clear that it might increase or decrease the amount of purchases depending on market conditions, while maintaining the annual pace of increase at about 6 trillion yen. The aim of these policy measures is to strengthen the sustainability of the current powerful monetary easing, taking into account the side effects. The Bank recognizes that the effects of monetary easing will be strengthened as a whole, in consideration of this sustainability. The Bank also recognizes the risk that, by continuing such powerful monetary easing, financial institutions' strength will be cumulatively affected by low profitability, mainly through a decrease in their lending margins, and thus the functioning of financial intermediation will be stagnant. Currently, as financial institutions have sufficient capital bases and their lending attitudes continue to be active, there is no serious problem with the functioning of financial intermediation. However, there is no change in the Bank's intention that it will thoroughly examine the risks considered most relevant to the conduct of monetary policy. As a central bank, the Bank will continue conducting monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions, so that the momentum toward 2 percent inflation will be maintained and the economy thereby will grow in a balanced manner between economic expansion and price stability. Conclusion To conclude, I would like to talk about the economy of Kyoto Prefecture. Kyoto Prefecture's economy can be judged as having been expanding, even though the effects of the torrential rains a while ago can be seen in part. In Kyoto, there are a number of global manufacturers that represent Japan in sectors of electronic parts and devices as well as industrial machinery. Moreover, Kyoto attracts attention from all over the world as an international tourist destination distinguished by more than 1,200 years of history. Thus, production and exports have been on an uptrend while steadily benefiting from the growth in overseas economies, and demand from foreign visitors also has been firm on the back of an increase in foreign tourists to Japan. In addition, business fixed investment has become more active, as seen in investment intended for capacity expansion as well as research and development in the manufacturing sector and that intended for extension of accommodation facilities such as hotels in the nonmanufacturing sector. Employee income also has increased moderately. Reflecting such favorable economic conditions, labor shortage has been progressing in Kyoto Prefecture, as is the case nationwide. In this situation, active labor participation by women and seniors has been observed and labor-saving investment in various forms is becoming more dynamic. For example, a wide range of firms irrespective of sector have established sections specializing in promoting diversity and worked on creating various working systems, such as shorter and flexible working hours. As a result, some have expressed the opinion that such moves have led to an increase in female and senior workers. In addition, many firms in the eating and drinking services as well as accommodations sectors, which are underpinned by demand from foreign visitors, have been making up for labor shortage by raising productivity, such as through introducing tablet devices and making use of the Internet of Things (IoT). As I have explained today, such moves may weaken upward pressure on wages and prices in the short term, but in the longer term, they will raise the productivity of the economy as a whole, thereby strengthening its growth potential. As this potential rises, firms' spending behavior and households' consumption are likely to become more active, eventually contributing to pushing up prices. Such positive developments that have been clearly observed in the prefecture are expected to support the achievement of the 2 percent price stability target in a stable manner. In closing, let me convey my best regards and express my sincere hope that you will continue to make Kyoto even more attractive while uniting tradition and innovation for the further development of the prefecture's economy. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kyoto August 2, 2018 Masayoshi Amamiya Deputy Governor of the Bank of Japan Chart 1 Japan's Economy Length of Economic Recovery Period Unemployment Rate Corporate Profits s.a., % s.a., % Rank Period Length February 2002February 2008 73 months December 2012- 66 months November 1965July 1970 (Izanagi Boom ) December 1986February 1991 (Bubble Boom ) November 1993May 1997 (as of May 2018) Ratio of current profits to sales (all industries and enterprises) 57 months 51 months 43 months CY 86 89 92 95 98 01 04 07 10 13 16 CY 86 89 92 95 98 01 04 07 10 13 16 Note: Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Sources: Cabinet Office; Ministry of Finance; Ministry of Internal Affairs and Communications. Chart 2 Output Gap and Consumer Prices Consumer Prices Output Gap y/y % chg. % -1 -2 -1 -3 -4 -2 -5 CPI (all items less fresh food) -3 -6 CPI (all items less fresh food and energy) -7 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -4 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. The output gap is based on BOJ staff estimations. Notes: 2. The CPI figures are adjusted for changes in the consumption tax rate. Sources: Bank of Japan; Ministry of Internal Affairs and Communications. Chart 3 Why Is the Bank Aiming at 2 Percent Inflation? Three Reasons Upward bias in the CPI Buffer for monetary policy 2 percent as a global standard Price Stability in Advanced Economies Country/ Region Definition United States (FRB) Longer-run goal Euro area (ECB) Quantitative definition United Kingdom (BOE) Target Japan (BOJ) Price stability target Indicator Numerical expression (y/y chg.) PCE deflator 2% HICP Below, but close to, 2% CPI 2% CPI 2% Chart 4 Firms' Cautious Wage-Setting Stance Labor Force Participants Wage Increases Seniors (aged 65 and over) Women (aged 15-64) y/y % chg. change from CY 2000, mil. persons change from CY 2000, mil. persons Scheduled cash earnings (full-time employees) Population Labor force participants Labor force participants Hourly scheduled cash earnings (part-time employees) Population -1 -2 -3 -4 -1 -5 -2 -6 CY 00 -2 16 CY00 Notes: 1. Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February in the wage graph. Wage figures from 2017/Q1 onward are based on existing respondents (continuing observation) following the sample revision of the Monthly Labour Survey in January 2018. Notes: 2. Figures for labor force participants and population for 2018 are January-May averages on a seasonally adjusted basis. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 5 Households' Tolerance of Price Rises DI ("favorable" - "unfavorable"), % points -70 tolerate price rises -75 -80 -85 -90 -95 CY 07 Note: Comments on the rise in prices are chosen among three alternatives: "rather favorable," "difficult to say," and "rather unfavorable." Source: Bank of Japan, Opinion Survey on the General Public's Views and Behavior. Chart 6 Firms' Cautious Price-Setting Stance Labor-Saving Investment in Sectors Facing Acute Labor Shortage Software Investment (Tankan) Employment Conditions DI (Tankan) -70 -60 FY2005 = 100 reversed, DI ("excessive" - "insufficient"), % points "insufficient" All industries All industries Construction -50 Retailing -40 Accommodations, eating & drinking services -30 Construction Retailing Accommodations, eating & drinking services -20 -10 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 FY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Note: Figures for software investment for fiscal 2018 are based on plans in the June 2018 survey. Source: Bank of Japan. Chart 7 Intensifying Competition Online-Shopping Ratio to Total Expenditure 3.5 Interview Responses by Firms - The Bank's Regional Economic Report (Jul. 2018)- % 3.0 Since competitors have intensified their pricecutting strategies, we may also cut sales prices further in the future (a supermarket [Sendai]). 2.5 2.0 1.5 1.0 0.5 0.0 CY 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Consumers have a deep-rooted cost-saving mentality and we are losing customers to lowprice retail businesses such as drugstores and online retailers (a supermarket [Kyoto]). We are feeling the threat of other types of retail businesses that have intensified their price-cutting strategies at the expense of profits, and thus we have cut the sales prices of several hundred items, especially privatebrand products (a supermarket [Hiroshima]). Notes: 1. Figures are calculated using "total expenditure on goods and services ordered over the Internet" from the Survey of Household Economy and "consumption expenditures" from the Family Income and Expenditure Survey. 2. In the right chart, the parentheses show the industry of the interviewee and the Bank branch. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 8 Moves to Raise Sales Prices Spread of Wage Increases to Prices Output Prices DI (Tankan) y/y % chg. DI ("rise" - "fall"), % points 2.0 Eating out 1.5 Services related to domestic duties 1.0 -10 -20 0.5 -30 Large enterprises 0.0 -40 -0.5 CY 12 Small enterprises -50 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. The CPI figures are adjusted for changes in the consumption tax rate. Notes: 2. There is a discontinuity in the data of the output prices DI in the December 2003 survey due to a change in the survey framework. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 9 Outlook for Economic Activity and Prices (July 2018 Outlook Report) the medians of the Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) Fiscal 2018 +1.5 +1.1 Forecasts made in April 2018 +1.6 +1.3 Fiscal 2019 +0.8 +1.5 Forecasts made in April 2018 +0.8 +1.8 Fiscal 2020 +0.8 +1.6 Forecasts made in April 2018 +0.8 +1.8 Note: Figures for the CPI (all items less fresh food) exclude the direct effects of the consumption tax hike. Source: Bank of Japan. Chart 10 Yield Curve Control 1.4 % Recent 1.2 Bottom of 10-year JGB yields (July 27, 2016) 1.0 0.8 Target level of the long-term interest rate: 0.6 around zero percent Short-term policy interest rate: minus 0.1 percent 0.4 0.2 0.0 -0.2 -0.4 -0.6 residual maturity, year Source: Bloomberg. Chart 11 Strengthening the Framework for Continuous Powerful Monetary Easing Taking more time than expected to achieve the price stability target of 2 percent. Maintaining the output gap as long as possible within positive territory is appropriate. Persistently Continuing with Powerful Monetary Easing Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." ⇒ Strengthening the commitment to achieving the price stability target Enhancing the sustainability of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Long-term interest rate: The Bank maintains the target level of around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. Purchases of ETFs: The Bank maintains the annual pace of increase in the amount outstanding of about 6 trillion yen. While doing so, the Bank may increase or decrease the amount of purchases depending on market conditions. etc. Achieving the price stability target of 2 percent at the earliest possible time while securing stability in economic and financial conditions. 11■
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the symposium commemorating the 30th anniversary of stock index futures, Tokyo, 3 September 2018.
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September 3, 2018 Bank of Japan Post-crisis Futures Markets Keynote speech at the symposium commemorating the 30th anniversary of stock index futures Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is a great honor to be invited to speak at this symposium commemorating the 30th anniversary of stock index futures in Japan. A decade has passed since the collapse of Lehman Brothers, which triggered the global financial crisis. During the last 10 years since that time, global financial markets have faced and have been affected by various negative political and economic shocks such as the European debt problem in the first half of the 2010s. Japanese stock and futures markets have not been immune and the turnover of cash stocks and the trading volume of stock futures were sluggish for some time after the global financial crisis (Chart 1). Thereafter, however, against the background of the recovery of the global economy and solid corporate performance, global financial markets have rebounded to pre-crisis levels. This year also marks the 5th anniversary of the business integration of the Tokyo Stock Exchange Group and the Osaka Securities Exchange. Even following the global financial crisis, various initiatives aimed at enhancing user-friendliness have been taken to meet the diverse needs of investors and firms including the introduction of new products, extension of trading hours, and IT system reform. Those initiatives have been vital for maintaining and enhancing the functions of the Japanese exchanges since the crisis, and I would like to pay tribute to all of those who have worked so hard to carry out those initiatives. Moving on, as it has been 30 years since stock index futures first appeared in Japan, let us take this opportunity to return to the basics and re-clarify the function of futures contracts; futures contracts, in principle, are used to "transfer risks," namely to hedge risks or speculate on price changes by trading assets on a future date at a predetermined price. In this regard, derivatives contracts such as forwards also have the same function. However, the two contracts differ in that forwards are derivatives contracts based on bilateral agreements between two parties, while futures are derivatives contracts that are traded on "exchanges," including clearing houses. Futures contracts traded on exchanges are standardized and offer the benefits of low transaction costs, fair and transparent price formation, risk management measures such as margin requirements and the marking to market of assets, and safe central clearing; thanks to these features, futures contracts are expected to attract more market participants and thereby realize enhanced market liquidity. Such enhanced market liquidity is in turn expected to strengthen the basic function of futures contracts, which, as I just mentioned, is to "transfer risks." Skepticism about the function of futures contracts sometimes emerges, especially when markets experience significant asset price fluctuations in the wake of a financial crisis. The typical assertion is that the existence of futures contracts amplifies spot price changes in the underlying assets. However, as long as futures markets offer enhanced market liquidity supported by the functions of exchanges, it is expected that the price discovery function inherent in futures would remain somewhat resilient even during a crisis, and this will thereby help the spot market to swiftly return to a price formation process that properly reflects the supply and demand conditions of the underlying assets and market participants' views. Given the role of exchanges and their relation to market liquidity, it is impressive that the world's first organized futures contracts -- which are similar to those currently traded on exchanges -- were already established in the 18th century at the Dojima Rice Exchange in Osaka. The fact that futures contracts in their long history have supported the development of the market economy and have overcome numerous crises by undergoing appropriate changes shows just how valuable they are. Also, it should be noted that various ongoing changes in the market environment since the global financial crisis have necessitated futures markets such as stock futures and commodity futures to undergo new transformations. Let me elaborate on new trends in futures markets and the challenges brought about by those trends. Post-crisis Trends in Futures Markets Tightening of Financial Regulations First, I would like to talk about the effects of the tightening of financial regulations. The global financial crisis following the collapse of Lehman Brothers adversely affected market liquidity in various financial transactions. The decline in market liquidity was particularly evident in bilateral over-the-counter (OTC) derivatives. Before the financial crisis, OTC derivatives were very popular among customers seeking higher profits because the bilateral flexibility of OTC derivatives enabled various customized structures to achieve higher yields. However, once the financial crisis occurred, there was suddenly a great deal of concern about the counterparty credit risks of financial institutions, particularly in the United States and Europe, and the flexible but complex structures of OTC derivatives made it difficult to pinpoint and specify the size of those risks. As a result, market liquidity of OTC derivatives declined significantly in a short period and there was a run on OTC derivatives markets, including a rapid reversal of investment positions. On the other hand, futures contracts traded on exchanges were processed in a generally stable manner even amid the financial crisis, as the risk management of exchanges and clearing through central counterparties (CCPs) proved somewhat effective. Thus, the functions of exchanges fostered over many years contributed to avoiding disruption of futures markets during the global financial crisis. It was therefore decided to incorporate the essence of those functions in the plan for OTC market reform. Specifically, in order to improve the transparency and robustness of contracts, standardized OTC derivatives contracts were obliged to be traded on exchanges or electronic trading platforms, and cleared through CCPs.1 Furthermore, the exchange of margins based on associated risks became mandatory for non-centrally cleared tailor-made OTC derivatives contracts. In view of those regulatory trends, there has been an increase overseas in the "futurization of OTC derivatives," which refers to the clearing of transactions through CCPs by listing futures contracts on exchanges in advance, mirroring the contractual conditions of OTC derivatives deals made with a certain frequency. In autumn 2009, the following agreements were reached at the Group of Twenty (G-20) Pittsburgh Summit: (1) all standardized OTC derivatives contracts should be traded on exchanges or electronic trading platforms and (2) cleared through CCPs; (3) OTC derivatives contracts should be reported to trade repositories; and (4) non-centrally cleared contracts should be subject to higher capital requirements. Accordingly, many OTC derivatives contracts have shifted to exchange trades and clearing through CCPs (Chart 2). However, this could give rise to several issues. For example, there are concerns that this change might increase moral hazard among market participants given that they do not directly bear counterparty credit risks and have less incentive to monitor credit risks. What is more, and perhaps the most crucial point, is that exchanges and clearing houses would face concentrated risks as they accommodate more OTC derivatives contracts reflecting the needs of market participants to mitigate counterparty credit risks. Accordingly, exchanges and clearing houses must appropriately manage and mitigate those concentrated risks so that futures and derivatives contracts traded on exchanges would be processed in a stable manner if there is another global financial crisis. To this end, it is also important for exchanges and clearing houses to ensure that they have appropriate levels of loss-absorbing capacity through assessments based on stress testing.2 Technological Innovation Second, I would like to mention the effects of innovation in the field of financial technology. The remarkable development in information technology in recent years has dramatically accelerated order processing. For example, in the stock market of the Tokyo Stock Exchange, the new "Arrowhead" trading system, which launched in January 2010, has enabled orders to be processed in milliseconds -- a speed which could never be matched by human ability. Against the background of this technological innovation, there has been a growing presence in financial markets of so-called high-frequency trading (HFT) players, who use automated algorithms to repeatedly execute small orders at extremely high speed and frequency. The prevalence of HFT might differ somewhat geographically, but for example, there is a view that the share of HFT in stock markets has reached around 50 percent in the United States and around 40 percent in Europe. That share has also increased in Japan, and the number of contracts executed from the co-location areas of the stock For details on global discussions regarding concentrated risks in financial market infrastructures due to the tightening of financial regulations, see "Seisankikan wo meguru global na taiou ni tsuite (Global Approach to Central Counterparties)," Payment and Settlement Systems Report Annex Series, August 2017 (available in Japanese only). market of the Tokyo Stock Exchange has reached around 40 percent (Chart 3).3 Equally, there is a view that the share of HFT in Japanese stock futures has reached a somewhat high level due to the introduction of IT systems designed for high-speed order processing. Positive assessments of HFT can be summarized as follows. First, there is a view that HFT has improved market liquidity as HFT players engage in "passive market making" against other investors by simultaneously placing a vast amount of "buy" and "sell" orders in order to exploit arbitrage opportunities on bid-ask spreads. Second, HFT in theory is expected to constrain stock price fluctuations and thereby reduce volatility as sell orders are placed when prices rise even slightly and buy orders are placed when prices decline. In fact, some empirical analyses have verified such an improvement in market liquidity and a decline in volatility.4 At the same time, some argue that HFT could reduce market liquidity and contribute to volatility in the event of a sudden shock that has a greater impact than forecasted by its algorithms.5 Some also voice concern over the risk that a large volume of irrational orders could be placed as a result of human error unintentionally embedded in an algorithm.6 It is believed that HFT players, who require faster access for transactions in milliseconds, usually place orders from co-location areas (special areas in the same building that hosts the primary systems of the exchanges where market participants can install their own servers containing trading algorithms). See, for example, "Kabushiki shijyou ni okeru kousoku kouhindo torihiki he no eikyou (Effects of High Speed and Frequency Trading on the Stock Market)," Bank of Japan Review, No. 13-J-2, January 2013 (available in Japanese only), which provides a theoretical summary of HFT and analysis of the effects on the Japanese stock market. In spite of the popular view at one time that attributed the "flash crash" in the U.S. stock market in May 2010 to HFT, a joint report by the U.S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC) concluded that the crash was not directly caused by HFT, but rather by a complex combination of factors. However, the report also pointed out that HFT players accelerated price fluctuations by rapidly withdrawing liquidity during the propagation of market turmoil. In August 2012, many stocks on the New York Stock Exchange experienced a "mini flash crash" due to a massive number of erroneous orders. The erroneous orders have been attributed to system issues caused by human error. As I mentioned, assessments of HFT have not been entirely positive. It is therefore important to consider measures and initiatives to ensure that the growing presence of HFT players contribute to enhancing market efficiency and liquidity through appropriate arbitrage and market-making activities and does not result only in transaction speed competition. For example, if the risks of high speed and frequency trading amplifying price changes due to one-sided algorithmic trades or a malfunction in programs and servers are left unattended, they might impair financial market stability, and in turn weaken the risk transfer and price discovery functions of futures markets. Tackling those issues is by no means an easy task, but it is critical to properly consider measures to prevent them. The specific measures to deal with those issues are not to be implemented by exchanges alone because they also rest on regulations on HFT and other factors. That said, with the advent of HFT and the growing presence of HFT players in financial markets, various self-imposed requirements for exchange trades associated with financial technological innovation and the role of exchanges in risk management and monitoring are becoming increasingly important. Increased Use of Futures for Asset Management Third, I would like to briefly touch on the effects of the widespread movement to use futures for asset management. Participants in futures markets are broadly divided into three classical categories: (1) hedgers, who hedge against price risks in underlying assets; speculators, who take on such price risks; and (3) arbitrageurs, who seek arbitrage between spot and futures markets. However, during the last 10 years since the global financial crisis, futures markets have witnessed the growing presence of new investment players that take long positions in the medium to long term, such as investment trusts and exchange-traded funds (ETFs). The increased use of futures for asset management, in addition to hedging and speculation, can be viewed favorably because it provides households with more options for portfolio selection. Furthermore, the growing presence of new buyers with medium- to long-term investment horizons could increase the market depth of futures markets. It can be expected that this would enhance market liquidity, and thereby improve the risk transfer and price discovery functions of futures markets. However, if the diversity of market participants is impaired due to the growing presence of a particular investor type, prices might cease to appropriately reflect the fundamentals behind the transactions because they might be excessively affected by trading strategies employed by those investors. In fact, the growing share of investment trusts and ETFs in futures markets has affected the correlation between different asset types. A typical example is the effects observed in price formation of overseas commodity futures such as crude oil. Since the global financial crisis, a large amount of investment funds has flowed to commodity futures markets in pursuit of higher yield against the background of global monetary relaxation. In this process, commodities became embedded in the global portfolios of large investors extending across multiple regions and assets. In general, in the event of an exogenous shock, global portfolio rebalancing moves multiple risky asset prices in the same direction. In this regard, for example, returns on commodity index futures showed little sign of correlation with those on global stock indices at least until the middle of the 2000s. However, as a wide range of investors have started to incorporate commodities in their asset portfolios since the financial crisis, the correlation between returns on commodity index futures and those on stock indices has structurally increased (Chart 4). In the long run, the impact on futures prices stemming from price fluctuations in other asset classes, in addition to the correlation between futures prices and the prices of underlying assets, could affect the risk transfer and price discovery functions of futures markets. In this sense as well, it is important to not only increase the number of market players but also gather a diverse set of investors with various investing styles and investment horizons. I hope an increasingly wider range of investors and greater investor diversity would continue to be observed. Concluding Remarks I have so far elaborated on new trends in futures markets brought about by significant environmental changes since the global financial crisis and the challenges brought by those trends, focusing on three perspectives: (1) tightening of financial regulations; technological innovation; and (3) increased use of futures for asset management. None of the challenges I mentioned today would be easy to tackle, but I believe that the functions of futures markets, which have offered benefits to financial markets for many years, would develop and be maintained if market participants take on these challenges and adapt to the new environment, just as they have done over the last 30 years. The Bank of Japan obtains information from futures markets that is valuable in understanding the markets' views and sentiment toward the economy and corporate performance. The Bank, as the central bank of Japan, would provide support through research studies and participation in discussions at home and abroad so that Japanese futures markets would develop in a more efficient and stable manner. Thank you for your attention.
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Speech by Mr Hitoshi Suzuki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Okinawa, 29 August 2018.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 25 September 2018.
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September 25, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka 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 a distinguished gathering of business leaders in the Kansai region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the various activities of the Bank of Japan's branches in Osaka, Kobe, and Kyoto. In my speech today, I would like to first talk about the Bank's view on the recent developments in economic activity and prices, and then explain its thinking behind the conduct of monetary policy. I. Economic Developments Let me start by talking about economic developments. Japan's economy is expanding moderately, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. Although the real GDP growth rate for the January-March quarter temporarily marked negative growth, due mainly to irregular weather, after continuing to register positive growth for eight consecutive quarters, the rate for the April-June quarter showed a return to firm growth, representing 3.0 percent on an annualized basis (Chart 1). The long-lasting recovery of Japan's economy is likely to be mainly attributable to both external and domestic demand increasing in a well-balanced manner. As for external demand, exports have continued on an increasing trend, exceeding the peak before the global financial crisis, led mainly by those of capital goods and IT-related goods, in which Japan has a comparative advantage (Chart 2). Looking at the underlying developments in overseas economies in detail, the U.S. economy has continued to expand firmly, with the growth rate for the April-June quarter registering 4 percent on an annualized basis. Firms' sentiment has continued to improve in both the manufacturing and nonmanufacturing sectors, and there has been positive momentum in private consumption on the back of the favorable employment and income situation. Meanwhile, the European economy has continued to recover on the whole with business fixed investment and private consumption following an uptrend; however, exports recently have decelerated somewhat, due mainly to the effects of the appreciation of the euro. As for emerging economies, the Chinese economy has continued to see stable growth on the whole with private investment and consumption remaining firm, although growth in infrastructure investment has decelerated somewhat. Other emerging economies, mainly Asian economies, have been recovering moderately, reflecting in part an increase in exports and the effects of their economic stimulus measures. Thus, while the momentum of economic recovery differs to some extent across countries and regions, the Bank judges that overseas economies have continued to grow firmly on the whole. Turning to the domestic situation, in the corporate sector, the profit environment has remained favorable, with the ratio of current profits to sales having been at a record high level (Chart 3). Under these circumstances, according to the Bank's June Tankan (Short-Term Economic Survey of Enterprises in Japan), firms' business fixed investment plans for fiscal 2018 showed the highest growth for this time of the year since the survey started. In the manufacturing sector, there has been a notable increase in research and development investment with a view to advancing next-generation technology such as self-driving systems and large-capacity batteries, in addition to investment intended for capacity expansion on the back of firm domestic and external demand. In the nonmanufacturing sector, investment aimed at improving efficiency and saving labor in order to deal with the recent labor shortage has maintained its high growth. Such improvement in the corporate sector has had positive effects on the household sector. In the labor market, the active job openings-to-applicants ratio is currently 1.63, the high level last seen during the period of high economic growth, and the unemployment rate has declined to around 2.5 percent, the level observed during the bubble period (Chart 4). While the number of employees has registered a year-on-year growth rate of around 2 percent, total cash earnings per employee have risen moderately but steadily, led mainly by those of part-time employees. Against the background of such improvement in the employment and income situation, private consumption has been increasing moderately, albeit with fluctuations. In terms of the contribution to economic growth, the recent increase in demand from foreign visitors cannot be ignored. Sales of duty free goods at department stores in the first half of this year registered an annual increase of close to 50 percent, and the occupancy rates of city hotels have maintained the high level of almost 80 percent for the past few years. On this point, as big events such as the Rugby World Cup and the G-20 summit are scheduled to be held in Osaka next year, I hear that the construction of new hotels and rebuilding of existing facilities have been taking place successively. As for the typhoon at the beginning of September, the Bank will make efforts to firmly grasp the impact of the damage caused, and expects that both the public and private sectors will work together to overcome the disaster and create regions that are even stronger and more attractive. So far, I have explained that Japan's economy has been improving, led by external and domestic demand in a well-balanced manner. With regard to the outlook, the economy is likely to continue its moderate expansion. However, there are various risks to this baseline scenario, and uncertainties regarding overseas economies in particular warrant attention. For example, it is necessary to thoroughly examine the extent to which recent protectionist moves, such as the trade friction between the United States and China, will affect trade as well as firms' investment activities. There have been active discussions over this issue at international conferences that I have taken part in, including the G-20 and G-7 meetings. In addition, the International Monetary Fund (IMF) recently released a simulation analysis of the effects of protectionist moves on the global economy. According to the simulation, downward pressure on the global economy stemming from stagnation in trade activity itself is likely to be 0.1 percentage point at most in the next five years. However, if such protectionist moves bring about turmoil in global financial markets and deterioration in firms' sentiment, downward pressure on the global economy is expected to be around 0.5 percentage point at most. Global economies have become more interdependent than ever before, with the recent progress in globalization and information technology. In this situation, it is clear that protectionist policies will not benefit any economy, regardless of whether it adopts such policies. Therefore, while a brake is expected to be put on excessive protectionist moves at some point, it is essential to continue global discussion to ensure this and to make sure that protectionist moves will not create instability in financial markets and firms' sentiment. Moreover, attention also should be paid to the effects that moves toward monetary policy normalization, including the policy rate hikes in the United States, will have on global capital flows and emerging economies. In fact, some emerging economies such as Turkey and Argentina -- where there are vulnerabilities in the economy including twin deficits and high inflation -- are confronted with a significant depreciation of their currencies, as the inflow of dollar-based capital into these economies has turned to an outflow. That said, the fundamentals of many other emerging economies including Asian economies have been firm, and the Federal Reserve seems to be conducting its policy by carefully taking account of developments in global financial markets and the global economy. Thus, it is fairly unlikely at this point that the problems happening in some emerging economies will spread widely. However, as sudden changes could arise in the market, we will continue to carefully examine developments in global financial markets and emerging economies. II. Price Developments Now I will move on to price developments. Prices have continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and the year-on-year rate of change in the consumer price index (CPI) excluding fresh food and energy prices has been in the range of 0.0-0.5 percent (Chart 5). After five years, Japan's economy is no longer in deflation, in the sense of a sustained decline in prices, but the Bank's price stability target of 2 percent inflation on an annual basis has not yet been achieved. For this reason, in the Outlook for Economic Activity and Prices (Outlook Report) released at the end of July, the Bank focused on examining the reasons for these sluggish price developments and updated the outlook for economic activity and prices. Today, I would like to outline some key points of the report. The first point is the reason why prices have been sluggish even though the economy has improved steadily. Basically, this is likely to be mainly attributable to the experience of prolonged low growth and deflation. The long and severe adjustment phase since the second half of the 1990s, including the financial crisis, brought about sluggishness in economic activity and asset prices. Under these circumstances, firms' wage- and price-setting stance as well as households' views toward price rises have become cautious. The Bank introduced quantitative and qualitative monetary easing (QQE) in 2013 and has been persistently conducting powerful monetary easing. However, as the mindset and behavior based on the assumption that wages and prices will not increase easily have become embedded in the economy over a long period of time, it has been taking time for the situation to change. In addition to such basic factors, the large room to raise productivity, mainly in the nonmanufacturing sector, as well as the technological progress such as digitalization in recent years, have allowed firms to maintain their cautious stance toward raising prices despite an increase in labor costs. For instance, many firms in the accommodations as well as eating and drinking services sectors have been compensating for a rise in personnel expenses by introducing online reservation and ordering systems using tablet devices. In addition, a further increase in labor participation by women and seniors in the past few years has eased labor shortage in part, serving as a factor slowing the pace of wage increases. In the long term, such moves are likely to strengthen the economy's growth potential and make firms' and households' spending activities more active, thereby contributing to pushing up prices. At least in the short term, however, these moves will weaken upward pressure on wages and prices due to the reasons I mentioned earlier. The second point concerning prices in Japan is that the mechanism for a rise in inflation itself is not lost, although its pace is sluggish. Moves to raise sales prices have been observed recently among a wide range of firms, reflecting rises in personnel expenses and prices of raw materials as well as components. Also, according to the Tankan, for the first time in about 10 years, the number of enterprises answering that the output prices have risen has been exceeding the number of those answering that such prices have fallen (Chart 6). Going forward, with the heightening perception of labor shortage, as wages of part-time employees continue to increase, its effects are likely to spread to wages of regular employees, mainly among small and medium-sized firms and the younger generations. In fact, at this year's annual spring labor-management wage negotiations, the rise in the rate of increase in base pay was more evident for small and medium-sized firms than for large firms, and summer bonuses increased more significantly than last year. Such moves are expected to ease consumers' cost-saving mentality and price rises by firms are likely to be more easily accepted accordingly. In this way, as a high level of utilization of labor and capital, or an improved output gap, is sustained, many of the factors that have been delaying inflation -- such as firms' cautious wage- and price-setting stance as well as households' cautiousness toward price rises -- will likely be resolved gradually. When further price rises come to be observed widely as a result of this, people's medium- to long-term inflation expectations are projected to rise gradually. As a consequence, the year-on-year rate of change in the CPI is likely to increase gradually toward the price stability target of 2 percent, although it will take more time than expected. In the July Outlook Report, the Bank projected that the year-on-year rates of change in the CPI (less fresh food) for fiscal 2018 through fiscal 2020 would likely be 1.1 percent, 1.5 percent, and 1.6 percent, respectively. We are in a difficult situation in terms of achieving 2 percent inflation by fiscal 2020. Nevertheless, maintaining a positive output gap -- a driver for a rise in inflation -- for a long time, which will firmly push up actual prices as well as inflation expectations, as I just mentioned, is likely to be the most certain path toward achieving 2 percent inflation. III. The Bank's Conduct of Monetary Policy Lastly, I would like to talk about the Bank's thinking behind the conduct of monetary policy. The Bank has been conducting powerful monetary easing under the framework of "QQE with Yield Curve Control," aiming to achieve the price stability target of 2 percent (Chart 7). In terms of yield curve control, with a view to facilitating the formation of the yield curve that is considered most appropriate for achieving 2 percent inflation, the Bank has purchased Japanese government bonds (JGBs) under the guideline for market operations, in which it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent. Under the circumstances, not only JGB yields, but also lending rates for firms as well as issuance rates for corporate bonds have remained at extremely low levels, and the amount outstanding of bank lending has been increasing. In addition, the Bank has purchased exchange-traded funds (ETFs) so that their amount outstanding will increase at an annual pace of about 6 trillion yen, with a view to lowering risk premia in the stock market and exerting positive effects on economic activity and prices. As I mentioned earlier, it is likely to take more time than expected to achieve 2 percent inflation. On the other hand, the mechanism whereby an improvement in the output gap leads to a rise in inflation has continued to operate. Considering such situation, the Bank judged it important to persistently continue with powerful monetary easing and decided at the July 2018 Monetary Policy Meeting (MPM) to strengthen the policy framework as follows (Chart 8). First, the Bank introduced forward guidance for policy rates. Specifically, it publicly made clear to "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." This is based on the recognition that, in a situation where achieving 2 percent inflation is taking time, simply stating that it will persistently continue with monetary easing cannot sufficiently ensure public confidence regarding its monetary policy. I hope the introduction of forward guidance makes clear the Bank's strong policy stance toward achieving the price stability target. With regard to this forward guidance, some point out that it is difficult to understand how long "for an extended period of time" means. First of all, as the words imply, it is not based on a specific period of time. The phrase "for an extended period of time" was often used by other central banks, presumably implying a fairly long period of time. Partly because central banks in the United States and Europe are proceeding with monetary policy normalization recently, some market participants speculated that a policy rate hike would take place soon even in Japan. However, the situation regarding the price stability target in Japan differs substantially from that in the United States and Europe. In terms of clarifying this point, it is very important to make clear that the Bank will maintain the current extremely low levels of short- and long-term interest rates for an extended period of time. Of course, "for an extended period of time" does not mean permanently. Such being the case, some may think that the period for which interest rate levels will be maintained should be linked to a specific period of time or price indicators, in order to ensure the effectiveness of the commitment. However, there are various uncertainties regarding economic activity and prices in Japan, as I mentioned earlier. Therefore, in designing forward guidance, we need to ensure not only the effectiveness of the commitment, but also the flexibility of the future policy conduct, and in a balanced manner. The same applies to forward guidance by other central banks. That is, in the initial stage following its introduction, as is the case in Japan, it is common to commit to maintaining interest rate levels while presenting qualitative conditions such as the economic situation and risk assessments, focusing rather on the flexibility of the policy conduct. In addition to the introduction of forward guidance, the Bank decided at the July MPM to enhance the sustainability of "QQE with Yield Curve Control." In persistently continuing with monetary easing, it is necessary to make adjustments to the policy framework so that it can function in a competent manner over the period of the easing's duration. For example, while the current target level of 10-year JGB yields is around zero percent, as I mentioned earlier, the Bank made it clear that, under the target, the long-term yields might move upward and downward to some extent mainly depending on developments in economic activity and prices, thereby conducting market operations in a more flexible manner. Yield curve control is an essential measure in stabilizing interest rates in Japan at low levels. On the other hand, because it is powerful, interest rate formation in the JGB market has been somewhat rigid, and there has been a notable decline in transactions. It is considered that the measures decided at the July MPM will mitigate the side effects accompanying such powerful monetary easing while facilitating the formation of an appropriate yield curve, and as a consequence, lead to enhancing the sustainability of the policy. In addition, as for ETF purchases, from the same aspect of enhancing the sustainability of the policy, the Bank made it clear that it might increase or decrease the amount of purchases depending on market conditions, while maintaining the annual pace of increase in the amount outstanding of about 6 trillion yen. Almost two months have passed since this policy decision was made. So far, stock prices and foreign exchange rates have been stable on the whole, and the Bank recognizes that its policy intention was accepted by market participants without misunderstanding. Meanwhile, in the JGB market, transactions have become more active and price movements have increased somewhat (Chart 9). According to a survey conducted in August, the proportion of respondents answering that the degree of bond market functioning "has improved" exceeded the proportion of those answering that it "has decreased" for the first time in about three years. As market transactions usually tend to decrease in summer and it is difficult to grasp actual developments, the Bank will continue to thoroughly examine the degree of recovery in market functioning. I have been given the opportunity to talk to you at this time every year, and this is the sixth occasion for me to do so since taking office as Governor of the Bank of Japan in April 2013. Six years ago, economic recovery had just started and overcoming deflation was not in sight. Under such developments in economic activity and prices, it was necessary to decisively implement a large-scale policy, and thus the policy that should be taken and the Bank's thinking behind it were simple and clear. Over the past five years, Japan's economy has continued its long-lasting recovery, corporate profits have been at record highs, and the employment situation has improved substantially. Wages and prices are no longer seeing a sustained decline and have turned to an uptrend. However, achieving the price stability target of 2 percent is taking more time than expected. In such a situation where economic activity and prices have improved significantly but their developments have been somewhat varied, it is appropriate to conduct monetary policy by taking account of a variety of developments in a comprehensive manner. This means that, in continuing with powerful monetary easing, we now need to consider both its positive effects and side effects in a balanced manner. The latest policy response is indeed in line with this thinking, and the Bank's stance toward aiming at price stability with a view to contributing to the sound development of the national economy has not changed at all. Going forward, it will continue to make its utmost efforts as a central bank, taking account of developments in economic activity and prices as well as financial conditions, and thereby firmly support corporate activities in Japan. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka September 25, 2018 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Japan's Economy Real GDP s.a., ann., tril. yen CY 05 Source: Cabinet Office. Chart 2 Exports and Overseas Economies Projections for Major Economies (IMF) Real Exports y/y % chg. s.a., CY 2015=100 World Projection Projection 3.2 3.7 3.9 3.9 Advanced economies 1.7 2.4 2.4 2.2 United States 1.5 2.3 2.9 2.7 Euro area 1.8 2.4 2.2 1.9 Japan 1.0 1.7 1.0 0.9 4.4 4.7 4.9 5.1 China 6.7 6.9 6.6 6.4 ASEAN-5 4.9 5.3 5.3 5.3 Emerging market and developing economies CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. The figure for real exports for 2018/Q3 is the July-August average. Notes: 2. The post-2018 figures in the right table are based on July 2018 WEO projections. Sources: IMF; Ministry of Finance; Bank of Japan. Chart 3 Corporate Profits and Business Fixed Investment Business Fixed Investment Plans (June Tankan) Corporate Profits s.a., % s.a., ann., tril. yen Ratio of current profits to sales (all industries and enterprises, left scale) Private nonresidential investment (SNA, real, right scale) -5 -10 -15 y/y % chg. ▼R&D investment FY ＋ 2.7 y/y % chg. ＋ 3.5 Business fixed investment (including land purchasing expenses) CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -20 FY 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 1718 Notes: 1. Figures for ratio of current profits to sales are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Notes: 2. Figures for business fixed investment (including land purchasing expenses) and R&D investment are based on the plans as of June Tankan in each fiscal year (all enterprises). Sources: Ministry of Finance; Cabinet Office; Bank of Japan. Chart 4 Employment Situation Active Job Openings-toApplicants Ratio 1.8 Unemployment Rate s.a., ratio s.a., % 1.6 1.4 1.2 1.0 0.8 0.6 0.4 CY 80 CY 80 15 18 15 18 Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 5 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY 10 Note: The CPI figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 6 Environment Surrounding Prices Changes in Prices (Tankan) Nominal Wages DI ("rise" - "fall"), % points y/y % chg. Base pay increase for full-time employees Change in output prices Change in input prices Scheduled cash earnings per fulltime employee Introduction of QQE (April 2013) -10 -20 -30 -40 CY 07 08 09 10 11 12 13 14 15 16 17 18 -1 FY 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Notes: 1. Figures in the left chart are those of all enterprises. Notes: 2. In the right chart, the figure for scheduled cash earnings per full-time employee for FY 2018 is the April-July average. That for base pay increase for FY 2018 is as of July 6, 2018. Sources: Ministry of Health, Labour and Welfare; Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Bank of Japan. Chart 7 Quantitative and Qualitative Monetary Easing with Yield Curve Control Yield Curve Control % 1.2 Recent JGB yield curve 1.0 0.8 Target level of the long-term interest rate: around zero percent 0.6 0.4 Short-term policy interest rate: minus 0.1 percent 0.2 0.0 -0.2 -0.4 residual maturity, year Source: Bloomberg. Chart 8 Strengthening the Framework for Continuous Powerful Monetary Easing Taking more time than expected to achieve the price stability target of 2 percent. Maintaining the output gap as long as possible within positive territory is appropriate. Persistently Continuing with Powerful Monetary Easing Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." ⇒ Strengthening the commitment to achieving the price stability target Enhancing the sustainability of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Long-term interest rate: The Bank maintains the target level of around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. Purchases of ETFs: The Bank maintains the annual pace of increase in the amount outstanding of about 6 trillion yen. While doing so, the Bank may increase or decrease the amount of purchases depending on market conditions. etc. Achieving the price stability target of 2 percent at the earliest possible time while securing stability in economic and financial conditions. Chart 9 JGB Market Transaction Volume for JGBs Bond Market Survey Degree of Bond Market Functioning (Change from Three Months Ago) 1.2 tril. yen/day Introduction of Yield Curve Control Strengthening the Framework for Continuous Powerful Monetary Easing 1.0 DI ("Has improved" - "Has decreased"), % points -10 0.8 -20 0.6 -30 Improve -40 0.4 -50 -60 0.2 -70 0.0 -80 Jan. July Jan. July Jan. July Jan. July Feb. Aug. Feb. Aug. Feb. Aug. Feb. Aug. Notes: 1. The left chart shows the trading volume via the Japan Bond Trading. Excluding T-bills, etc. The figure for September 2018 is the September 1-20 average. Notes: 2. In the right chart, the survey from February 2018 onward includes responses from major insurance companies, asset management companies, etc., in addition to those from eligible Notes: 2. institutions for the Bank's outright purchases and sales of JGBs. The latest survey was conducted from August 8-16, 2018. Sources: QUICK; Bank of Japan.
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Speech by Mr Goushi Kataoka, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kanagawa, 6 September 2018.
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September 6, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kanagawa Goushi Kataoka Member of the Policy Board (English translation based on the Japanese original) I. Economic Activity and Prices A. Recent Developments and Outlook for Economic Activity at Home and Abroad I would like to start my speech by looking at global economic trends affecting Japan's economy. I expect the global economy to grow moderately in 2018, accompanied by improvements in business fixed investment and exports. The U.S. economy has been favorable, underpinned in part by fiscal policy, and the inflation rate is expected to be at around 2 percent for the time being. As for the European economy, although the rapid growth in the second half of 2017 came to a halt, private consumption and corporate investment have been solid. The Chinese economy has continued to see stable growth on the whole, and other emerging economies have generally maintained their moderate recovery trend. According to Chart 1, which shows the economic outlook released by international organizations, growth rates of the global economy for 2019 are projected to remain more or less unchanged from 2018. Although growth rates of major advanced economies for 2019 are likely to weaken somewhat compared with those for 2018, the weakening is expected to be offset by growth in emerging economies. As I mentioned, international organizations have projected that the global economy is expected to continue on a steady expanding trend in 2019. Nonetheless, I am convinced that there is an increasing possibility that the pace of expansion in the global economy will decelerate somewhat from next year, considering the recent gradual heightening of uncertainties such as U.S. monetary tightening and its impact on global financial markets, protectionist moves and their effects, and negotiations on the United Kingdom's exit from the European Union (EU). In particular, trade friction has become increasingly severe and the situation requires caution. Chart 2 shows the economic impact of trade friction estimated by the International Monetary Fund (IMF). Under certain assumptions, the direct influence of raising tariffs is said to be limited. However, if tariffs placed on automobiles and auto components are raised, the economic influence exerted through exports and imports will be large. Moreover, the impact on the global economy cannot be ignored if intensifying trade friction leads to stagnation in business fixed investment or to a decline in stock prices through a deterioration in the sentiment of firms or investors. In a situation where uncertainties are gradually increasing, developments in overseas economies require further attention. Next, I would like to turn to developments in Japan's economy. The real GDP growth rate for the April-June quarter of 2018 recovered to positive territory after a decline in the previous quarter. This was supported by moderate growth in the global economy and the rebound from sluggish domestic demand due to factors such as severe winter weather. Chart 3 shows the real GDP growth rate and the breakdown by component. The contribution of domestic demand to total growth became larger as business fixed investment accelerated and as private consumption started to increase on the back of improvements in the employment and income situation. On the other hand, the contribution of external demand declined in response to a decrease in exports of services. Although exports of goods for the April-June quarter were firm, the influence of developments in trade friction warrants close attention. Turning to the outlook for Japan's economy, as shown in Chart 4, the medians of forecasts made by the Bank of Japan's Policy Board members for real GDP growth rates presented in the July 2018 Outlook for Economic Activity and Prices (Outlook Report) are 1.5 percent for fiscal 2018, and 0.8 percent for both fiscal 2019 and 2020. My view, however, is that the pace of growth will be somewhat more moderate than these forecasts. Specifically, the real GDP growth rate for fiscal 2018 is likely to be around 1.0 percent, mainly due to an increase in business fixed investment reflecting improvements in corporate profits and business sentiment, and to a rise in exports reflecting the expansion of overseas economies. The rate for fiscal 2019 is likely to slow and move in the range of 0.5-1.0 percent as the pace of expansion in the global economy will probably decelerate and as domestic demand is likely to deteriorate mainly reflecting the effects of the consumption tax hike scheduled to take place in October 2019. Moreover, the rate for fiscal 2020 is likely to be only around 0.5 percent. Indeed, one of the key events for Japan's economy when making growth rate projections is the consumption tax hike scheduled for October 2019. The direct burden on households of the upcoming consumption tax hike could be small since the rate increase -- from 8 percent to 10 percent -- is smaller than that of the April 2014 hike, and because a reduced tax rate is scheduled to be applied to some items. However, as shown in the left-hand graph of Chart 5, even after four years since the 2014 hike, household consumption has at last recovered to the level of April in the year prior to the hike. Moreover, I believe that household consumption remains vulnerable, as seen in real private consumption by type in the consumption activity index (CAI) shown in the right-hand graph of Chart 5; although consumption of durable goods and services has been increasing, albeit with fluctuations, that of non-durable goods including food, beverages, and clothes has continued to be sluggish. As long as such weakness remains, we must not underestimate the effects of the tax hike on consumption. Furthermore, I consider that economic growth for fiscal 2019 and onward is likely to decelerate, taking into account the following factors through fiscal 2020: (1) the possibility that the expanding trend of domestic business fixed investment will come to a halt, mainly due to the dissipation of Olympic Games-related demand, and (2) the possible materialization of the aforementioned risks surrounding developments in overseas economies. B. Recent Developments and Outlook for Prices Next, I will move on to price developments in Japan. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food for July 2018 was 0.8 percent, as shown in the left-hand graph of Chart 6. However, it should be noted that the contribution of a rise in energy prices to the CPI was significant at 0.5 percentage point, and the rate of increase for all items less fresh food and energy, which directly reflects supply-demand conditions, stood at only 0.3 percent year on year. In assessing prices, it is important to grasp underlying developments, excluding those CPI items with large fluctuations. The right-hand graph of Chart 6 shows some indicators that represent the underlying developments in consumer prices. These have been on a downtrend since March 2018, and I would therefore argue that the trend momentum of inflation has weakened. The important indicators that affect underlying price developments are the output gap and medium- to long-term inflation expectations. The output gap, as shown in the left-hand graph of Chart 7, has moved further into positive territory, reflecting improvements in the capital stock and labor markets. Nevertheless, the trend momentum of inflation has been weakening. This inconsistency between a widening output gap and weakening inflation may be the result of a number of factors. The July 2018 Outlook Report showed that households' tolerance of price rises has not been increasing and that firms' wage- and price-setting stance has not strengthened enough, even amid rising costs.1 Economic activity based on these conditions is not sustainable in the long run, although it is difficult to change in the short run; thus, if the expanding trend of the output gap continues to strengthen, economic activity will gradually become proactive, and the burden of price stagnation will be lessened. Meanwhile, inflation expectations have been somewhat weak. I am convinced that this is attributable to the adverse effects of prolonged deflation in the past and recent weak price developments. In addition, I believe that the weakening of the Bank's commitment to achieving the 2 percent price stability target is also affecting expectations. Turning to the outlook for prices, the medians of the Policy Board members' forecasts for the year-on-year rate of change in the CPI (all items less fresh food) presented in the July Outlook Report are 1.1 percent for fiscal 2018 and, excluding the direct effects of the scheduled consumption tax hike, 1.5 percent for fiscal 2019 and 1.6 percent for fiscal 2020 (Chart 4). In contrast to the April Outlook Report, the latest price projections have been revised downward, reflecting the current weak price developments, but the Bank's principal view is that the momentum of prices toward the 2 percent price stability target will be maintained. However, I dissented from the relevant description in the July Outlook Report as I think the possibility of the inflation rate rising toward 2 percent is low at the moment and that the momentum of inflation has weakened. I would like to explain this in relation to the Bank's conduct of monetary policy. For details, see Box 1 through Box 7 in the Bank's July 2018 Outlook Report. II. Conduct of Monetary Policy Let me first explain the Bank's current monetary policy framework, including the decision made in the July 2018 Monetary Policy Meeting (MPM). I would then like to touch on my opinion about the policy measures necessary to achieve the price stability target. A. Framework of Monetary Policy Conduct As shown in Chart 8, the Bank conducts monetary policy under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the 2 percent price stability target. This current framework consists of three major components. The first is yield curve control, in which the Bank controls short- and long-term interest rates. Specifically, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields remain at around 0 percent, thereby achieving accommodative financial conditions and stimulating economic activity and prices. The second component is purchases of assets such as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs), which are conducted with a view to exerting positive effects on economic activity and prices through lowering risk premiums such as on stocks. The third component is the commitment regarding the future conduct of monetary policy. Under the inflation-overshooting commitment introduced in September 2016, the Bank continues to expand 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 this target level in a stable manner. With this commitment, the Bank aims to increase the credibility that it will achieve the 2 percent price stability target by ruling out the possibility of a change in the direction of monetary policy at an early stage when achievement of the target comes in sight. In this situation, as I explained earlier, the CPI forecasts of the Policy Board members were revised downward again in the July 2018 Outlook Report, on the view that it is taking more time than expected to achieve the price stability target of 2 percent. Nevertheless, although it will take time, it is necessary to maintain and strengthen the momentum of prices toward achieving the price stability target. Based on this recognition, the Bank decided at the July 2018 MPM that it was desirable to maintain the output gap within positive territory as long as possible by persistently continuing with the current monetary easing, thereby ensuring the price developments toward achieving 2 percent inflation. As a result of the discussion, the Bank decided on a statement titled "Strengthening the Framework for Continuous Powerful Monetary Easing" to address two challenges that could arise from the continuation of monetary easing. The first is to further strengthen confidence among the public regarding the Bank's current policy stance that aims at achieving the price stability target. The second is to strengthen the sustainability of the current monetary easing so that the effects of monetary easing will not weaken, while taking care of the possible negative effects on financial markets. Chart 8 provides a comparison of the key features of "Strengthening the Framework for Continuous Powerful Monetary Easing" with those of the previous policy framework. The first feature is enhancing the sustainability of yield curve control. Specifically, the Bank decided to allow some degree of fluctuation in the long-term yields, depending mainly on developments in economic activity and prices, while maintaining the target level for 10-year JGB yields at around 0 percent. This aims at continuing with powerful monetary easing while alleviating concerns about a possible decline in the functioning of the JGB market. The second feature is the Bank's announcement that it might increase or decrease the amount of ETF purchases, depending on market conditions, with a view to enhancing the sustainability of the policy, while maintaining the guideline that the amount outstanding of ETF purchases by the Bank will increase at an annual pace of about 6 trillion yen. The third feature is the introduction of forward guidance for short- and long-term interest rates. Specifically, the following commitment was announced: "[t]he Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." By announcing its intention regarding the guideline for controlling interest rates, in addition to the inflation-overshooting commitment that has been in place since September 2016, the Bank aims to strengthen market confidence and expectations regarding monetary policy. B. Measures Necessary for Achieving the Price Stability Target I dissented from "Strengthening the Framework for Continuous Powerful Monetary Easing" considering that (1) taking account of the current sluggishness in prices and risk factors going forward, it was desirable to strengthen monetary easing itself, and (2) controlling the long-term yields in a flexible manner would make their target level of around 0 percent unclear. In relation to this, I would like to raise three issues. First, I consider that additional monetary easing -- rather than strengthening the framework for continuous easing -- should be implemented in a situation where the Policy Board members' forecasts are being revised downward. To justify the assessment that it is appropriate to persistently continue with the current monetary easing, the degree of the current easing needs to be strong enough to achieve the price stability target. The key to making such an assessment is whether, under the current policy, the momentum for inflation has strengthened or is likely to strengthen going forward. Let us first examine the momentum based on developments in two indicators: the output gap and inflation expectations. The output gap might stay in positive territory, but with the prospect of economic growth decelerating from 2019, the pace of the widening of the output gap will likely slow down. Amid relatively weak inflation rates, inflation expectations are likely to remain somewhat weak through the adaptive formation mechanism. Therefore, I believe there is little likelihood of the momentum increasing under the current policy. Another way to assess the momentum in inflation is the pace at which price rises will lead to achievement of the price stability target of 2 percent. Chart 9 shows a statistical estimate of the probability of Japan's inflation rate reaching 2 percent within two years.2 Based on the assumption that the average of the changes in the monthly inflation rate over the past year will continue, the 2 percent-passage probability has declined since May 2018. This suggests that the momentum in inflation has weakened somewhat. Moreover, the 2 percent-passage probability calculated using the CPI for all items less fresh food and energy has been almost 0 percent since mid-2016, indicating that the momentum over the past year or so was mostly attributable to energy prices. In other words, it is possible to conclude that, under the current monetary policy, the momentum in inflation has not strengthened enough to achieve the price stability target as soon as possible. Second, I believe that it is unnecessary for the Bank to conduct policy changes so as to allow some degree of fluctuation in the long-term yields, at a time when the CPI forecasts of the Policy Board members have been revised downward. Personally, I am concerned about this policy change, in that it is possible that the long-term interest rate target level of around 0 percent will gradually lose significance if expectations of a rise in long-term yields heighten in financial markets. The timing of achieving the price stability target may be delayed if interest rates rise, whether temporarily or not, in a situation where inflation expectations and prices have not risen sufficiently. Furthermore, one advantage of yield-curve control is that it strengthens the monetary easing effects by maintaining long-term interest rates at around 0 percent when they are subject to upward pressure; however, controlling long-term yields in a flexible manner is thought to weaken such effects. Third, as for the Bank's commitment regarding future monetary policy changes and forward guidance for policy rates, my view is that, taking into account the current situation in which the observed inflation rate is still evidently far from the 2 percent price stability target, it is important for the Bank to make clear the influence of its monetary policy on prices and to show its strong determination to achieve the price stability target. It is true that enforcing the Bank's commitment is desirable, given the continued relative weakness in inflation Presuming that the first passage time probability of a stochastic process obeys the Wald distribution, the probability of inflation rates hitting a threshold before a time horizon is estimated, assuming a 2 percent threshold and measurement horizon of two years. expectations. Nonetheless, I believe that the description of forward guidance introduced by the Bank in July -- "[t]he Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time" -- is just the natural conclusion to be drawn from the Policy Board members' CPI forecasts and the observed inflation rate clearly being far from the 2 percent price stability target. I am not sure whether the description does anything other than merely acknowledge the current situation. Rather, the Bank should design its forward guidance by clarifying the relationship of that guidance to the inflation rate, inflation expectations, and the output gap, with a view to strengthening its influence on prices. As I have explained, my view is that the current monetary easing measures are not strong enough to achieve the price stability target as soon as possible, and if the Bank allows long-term yields to rise when the inflation rate and inflation expectations have not risen sufficiently, the timing of achieving the price stability target may be delayed. As presented in the joint statement by the Bank and the government, the Bank's mission is to achieve the price stability target at the earliest possible time. Instead of strengthening the framework for persistently continuing monetary easing, it is important to strengthen monetary easing itself so that the easing will not be so persistent. Given that prices are sluggish and there are concerns over increasing uncertainties, it is important to exert a stronger influence over economic activity and prices. Specifically, I believe that the Bank should introduce a measure to further lower yields on JGBs with maturities of 10 years and longer, thereby accelerating the pace of widening of the output gap. Such a measure would create a more significant change in the behavior of firms and households in terms of setting wages and prices. Regarding the Bank's commitment to future monetary policy, I am of the view that the Bank needs to make clear its stance of not tolerating sluggish inflation expectations. In doing so, the Bank at this point needs to encourage inflation expectations to rise by making a commitment to taking additional easing measures if it revises downward its assessment of inflation expectations. Thank you for your attention. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kanagawa September 6, 2018 Goushi Kataoka Member of the Policy Board of the Bank of Japan Global Economic Outlook by International Organizations Chart 1 y/y % chg. Advanced Economies IMF World Japan United States Euro area Germany France Emerging Economies United Kingdom China Brazil India Russia OECD 3.7 1.7 2.3 2.4 2.5 2.3 1.7 6.9 1.0 6.7 1.5 3.9 1.0 2.9 2.2 2.2 1.8 1.4 6.6 1.8 7.3 1.7 3.9 0.9 2.7 1.9 2.1 1.7 1.5 6.4 2.5 7.5 1.5 3.7 1.7 2.3 2.6 2.5 2.3 1.8 6.9 1.0 6.5 1.5 3.8 1.2 2.9 2.2 2.1 1.9 1.4 6.7 2.0 7.4 1.8 3.9 1.2 2.8 2.1 2.1 1.9 1.3 6.4 2.8 7.5 1.5 Note: Data for 2017 are actual figures, otherwise projections. For India, data and forecasts are presented on a fiscal year basis. Source: IMF, “World Economic Outlook Update, July 2018”; OECD, “Economic Outlook, May 2018.” Chart 2 Impact of Trade Friction on Economic Growth (Simulation Analysis by the IMF) % Japan’s Economy Global Economy % Scenario 1 Scenario 2 Scenario 3 Scenario 1 Scenario 3 Scenario 2 Scenario 4 Scenario 4 years elapsed years elapsed Notes: 1. In both graphs, vertical axes show deviation of real GDP level from baseline in percent, and horizontal axes show years elapsed from the imposition of tariffs. 2. “Scenario 1: adopted tariffs” incorporates tariffs that have already been implemented by the United States, with retaliation of equivalent size. “Scenario 2: additional tariffs” adds to Scenario 1 an additional 10 percent tariff on US$200 billion worth of U.S. imports from China, with retaliation of equivalent size. “Scenario 3: car tariffs” adds to Scenario 2 a 25 percent increase in tariffs on U.S. imports of vehicles, with retaliation from all affected regions on an equivalent amount of U.S. exports. “Scenario 4: confidence shock” introduces a temporary global shock to confidence on top of Scenario 3. It is assumed that advanced economies see risk premiums increase by 30 basis points -- about half the increase observed during the “taper tantrum” -- around two years after the additional tariffs, while emerging economies would face a shock that is twice as large. Source: IMF, ”G20 Surveillance Note, July 21-22, 2018.” Chart 3 Real GDP Growth and Breakdown by Component ann., q/q % chg. Private consumption Government spending Imports Real GDP Private business fixed investment, etc. Exports Change in inventories, etc. -5 -10 -15 CYCY 17 17 Source: Cabinet Office, “Quarterly Estimates of GDP for April-June 2018 (First Preliminary Estimates).” Chart 4 Outlook for Economic Activity and Prices (July 2018 Outlook Report) medians of Policy Board members’ forecasts, y/y % chg. Fiscal 2018 Forecasts made in April 2018 Fiscal 2019 Forecasts made in April 2018 Fiscal 2020 Forecasts made in April 2018 Real GDP CPI (all items less fresh food) +1.5 +1.1 +1.6 +1.3 +0.8 +1.5 +0.8 +1.8 +0.8 +1.6 +0.8 +1.8 Note: Figures for the CPI (all items less fresh food) exclude the direct effects of the consumption tax hike scheduled to take place in October 2019. Source: Bank of Japan, “Outlook for Economic Activity and Prices,” July 2018. Chart 5 Household Consumption Before and After Consumption Tax Hikes Consumption Before and After Tax Hikes Real Private Consumption by Type Apr. 1996 and Apr. 2013 = 100 104.9 Durable goods 104.6 120 103.9 Non-durable goods Services 100.5 122.3 Tax hike in fiscal 2014 (from 5% to 8%) Tax hike in fiscal 1997 (from 3% to 5%) Apr. 2013 = 100 106.9 106.3 103.0 99.4 95.8 87.7 96.8 13 FY 1996 14 FY 2013 92.8 Note: The latest figures are as of June 2001 and June 2018. Source: Cabinet Office, “Synthetic Consumption Index.” 13 年度 FY 2013 14 Notes: 1. The latest figures are as of June 2018. 2. “Durable goods” includes household appliances and automobiles. “Non-durable goods” includes food, beverages, and clothes. 3. The weights in the Consumption Activity Index are 9.4 percent for “Durable goods,” 39.1 percent for “Non-durable goods,” and 51.5 percent for “Services.” Source: Bank of Japan, “Consumption Activity Index.” Chart 6 Consumer Prices Consumer Price Index 2.0 Measures of Underlying Inflation y/y % chg. y/y % chg. % points 1.0 1.5 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 -1.0 -1.5 Trimmed mean CPI (all items less fresh food) Weighted median CPI (all items less fresh food and energy) Diffusion index (right scale) -1.0 -2.0 CY 2011 12 12 13 13 14 14 15 15 16 16 17 17 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications, ”Consumer Price Index.” -50 CY CY11 Note: The diffusion index is the share of increasing items minus that of decreasing items. The share of increasing/decreasing items is the share of items in the CPI (all items less fresh food) whose price indices increased/decreased from a year earlier. Source: Bank of Japan, “Measures of Underlying Inflation.” Output Gap and Inflation Expectations Output Gap %, % points y/y % chg. 5.10% (1990/4Q) 1.83% (1997/1Q) 2.09% (2007/4Q) 2.0 Chart 7 Synthetic Indicators of Inflation Expectations y/y % chg. 1.71% (2018/1Q) Firms, households, and experts (Consensus Forecasts) Firms, households, and experts (QUICK Survey) Firms, households, and markets (inflation swap rate) 1.5 1.0 -2 0.5 -4 0.0 CY 10 -2 Labor input gap -4 Capital input gap -6 -8 CY 1985 Output gap Reference: CPI (all items less fresh food, energy, and consumption tax hike; right scale) Notes: 1. The data of the output gap in the left-hand graph are the estimates as of July 4, 2018. 2. In the right-hand graph, semiannual data from the Consensus Forecasts up through 2014/Q2 are linearly interpolated. Figures for the Bank’s Opinion Survey on General Public’s Views and Behavior exclude inflation expectations by respondents whose annual inflation expectations were ±5% or greater. 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. 3. In the right-hand graph, inflation expectations of firms are taken from the Tankan and those of households are taken from the Bank’s Opinion Survey. For experts’ and markets’ inflation expectations, data from the Consensus Forecasts, the QUICK Survey, and the inflation swap rate are used as indicated by their respective lines. Sources: Ministry of Internal Affairs and Communications, ”Consumer Price Index”; Consensus Economics Inc., “Consensus Forecasts”; QUICK, "QUICK Monthly Market Survey (Bonds)"; Bloomberg; Bank of Japan. Strengthening the Framework for Continuous Powerful Monetary Easing Chart 8 (1) Yield Curve Control Short-term rate : minus 0.1% Long-term rate : around 0% Short-term rate : minus 0.1% Long-term rate : around 0%. The yields may move upward and downward to some extent depending mainly on developments in economic activity and prices. (2) Asset Purchases (Target Amount of Net Purchases) ETFs : 6 tril. yen per year J-REITs : 90 bil. yen per year ETFs : 6 tril. yen per year J-REITs : 90 bil. yen per year The Bank may increase or decrease the amount of purchases depending on market conditions. (3) Commitment (Future Monetary Policy Commitment) Inflation-overshooting commitment “The Bank 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.” Inflation-overshooting commitment Forward guidance for policy rates “The Bank intends to maintain the current extremely low levels of short- and longterm interest rates for an extended period of time.” Chart 9 Inflation Momentum (Measured by 2 Percent-Passage Probability) 0.9 0.9 0.8 0.8 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 0.1 CY 1991 91 93 CY 2013 CPI (all items less fresh food) CPI (all items less fresh food and energy) Note: Presuming that the first passage time probability of a stochastic process obeys the Wald distribution, the probability of inflation rates hitting a threshold before a time horizon is estimated, assuming a 2 percent threshold and measurement horizon of two years. The inflation momentum is assessed based on the assumption that the average of the changes in the monthly inflation rate over the past year will continue. Source: Ministry of Internal Affairs and Communications, ”Consumer Price Index.”
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kyoto, 2 August 2018.
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August 2, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kyoto Masayoshi Amamiya Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Before I begin my speech, I would like to extend my sincere condolences to the victims of the torrential rains last month and express my deepest sympathies to those who are suffering. Some areas, especially in the northern part of Kyoto Prefecture, continue to be severely affected and there is still much to be worried about. I am very honored to have the opportunity to exchange views with administrative, financial, and business leaders in Kyoto Prefecture today. 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 Kyoto Branch. At the Monetary Policy Meeting (MPM) two days ago, the Bank released its quarterly Outlook for Economic Activity and Prices (Outlook Report) containing the projections for Japan's economic activity and prices through fiscal 2020 and a detailed analysis on price developments. In addition, it strengthened the policy framework with a view to persistently continuing with the current powerful monetary easing. Today, I would like to explain the Bank's view on economic activity and prices as well as the new policy measures, while outlining the Outlook Report. I. Economic Developments in Japan Let me start with economic developments in Japan. Japan's economy has improved significantly over the past five years. The current economic recovery phase, which began in December 2012, has reached 66 consecutive months this May. If this recovery continues through January next year, it could overtake the longest post-war expansion of the economy so far, which lasted 73 months. Corporate profits have been at record high levels, and the labor market has been close to full employment, with the unemployment rate being in the range of 2.0-2.5 percent -- the lowest level in around 25 years (Chart 1). Confirming this situation by looking at the output gap, which represents the utilization of capital and labor, shows that it exceeded the long-term average of 0 percent around 2013, clearly turned positive in the second half of 2016, and since then has been widening further within positive territory (Chart 2). Turning to wages and prices, a base pay increase has been achieved for five consecutive years as a result of wage negotiations. In addition, the year-on-year rate of change in the consumer price index (CPI) excluding energy and fresh food has been on an uptrend for more than four and a half years since autumn 2013, and Japan's economy is no longer in deflation, in the sense of a sustained decline in prices. II. Price Developments Thus, Japan's economic activity and prices have improved steadily over the past five years. However, prices have continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and the Bank's price stability target of 2 percent in terms of the annual inflation rate has not yet been achieved. For this reason, in formulating the latest Outlook Report, the Bank focused on examining the reasons for these sluggish price developments and their outlook. In what follows, I would like to present the contents of the report and talk in more detail about the price situation in Japan. A. Why Is the Bank Aiming at 2 Percent Inflation? Before explaining the background to the continued relatively weak developments in prices, I will first talk about the reasons why the Bank is aiming at achieving the price stability target of 2 percent. I start with this topic because people often make comments such as "The price stability target of 2 percent is too high in the first place and it may not be necessary to aim at it forcibly," or "As long as the economy is growing, it would be better if prices do not rise." The fundamental mission of central banks in conducting monetary policy is to achieve price stability. Price stability is a situation that is neither deflationary nor inflationary -- in other words, prices neither rise nor fall -- and thus could mean that the year-on-year rate of change is 0 percent in numerical terms. However, the specific definition of price stability currently shared among advanced economies is that a slightly positive annual inflation rate, rather than a rate of 0 percent, would be desirable (Chart 3). The first reason is that the CPI -- the price statistics that many central banks refer to -- has a statistical tendency of demonstrating a slightly higher inflation rate than the actual one. While I will not explain this in detail, as it is somewhat technical, considering such statistical tendency, or upward bias, an appropriate figure for price stability in terms of the CPI is a slightly positive figure. The second reason for aiming at 2 percent inflation is the need to have a buffer for monetary policy. Central banks usually respond to inflation and deflation by raising or lowering interest rates. In the event of inflation, central banks can raise interest rates as much as necessary to suppress inflation. The reason for this is that there is no ceiling to interest rates. On the other hand, when we face deflation, there is a limit to the extent to which interest rates can be lowered. In recent years, a new approach employing negative interest rates has been developed, but it remains impossible to lower interest rates without limits. Deflation is a more troublesome phenomenon than inflation in the sense that central banks' ability to respond to the former is limited. Thus, it is desirable to have a buffer for monetary policy; that is, to secure a certain "margin" of positive inflation and positive interest rates in advance, so that central banks can take appropriate responses through monetary easing if the economy heads toward deflation. What these two reasons imply is that we should aim at a slightly positive inflation rate. However, there is no simple answer as to whether this should be 1 percent, 2 percent, or 3 percent. The important point is that central banks in major advanced economies more or less commonly define price stability as 2 percent. Of course, this is not based on a reckless argument that we should simply do what others are doing because there is no conclusive evidence as to what the inflation target should be. The reason why major advanced economies share the same inflation target and achieve a similar price situation is that, from a long-term perspective, this is likely to result in stable exchange rates. While exchange rates fluctuate due to a variety of factors in the short term, their trend over a longer term of 5 or 10 years reflects the difference in inflation between two countries. This is the concept of purchasing power parity. Therefore, aiming at the global standard of 2 percent inflation is very important in achieving stability in business management and in the economy as a whole through stable exchange rates. So far, I have provided three reasons why the Bank is aiming at the price stability target of 2 percent. However, I would like you to understand that the Bank does not think that it is enough simply to achieve 2 percent inflation. If only prices rise, real wages will decrease and economic activity will stagnate. As clearly stipulated in the Bank of Japan Act, the Bank shall implement monetary policy "aimed at achieving price stability, thereby contributing to the sound development of the national economy." Thus, the Bank aims at an economy in which prices rise moderately, as economic activity becomes more dynamic through increases in firms' sales and fixed investment as well as improvement in households' employment, wages, and consumption. An economy in which a virtuous cycle among prices, wages, and economic activity continues to operate would create a world in which the price stability target of 2 percent is achieved. B. Why Are Prices Sluggish? However, we are still halfway toward achieving the price stability target of 2 percent. The latest Outlook Report presents a fairly detailed analysis on reasons why prices have remained sluggish even though the economy has improved significantly. Today I would like to present the essence of the report. There are likely to be two main factors behind the fact that the pace of improvement in prices has remained moderate. One is that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households due to the experience of prolonged low growth and deflation. The other is that the large room to raise productivity and the technological progress in recent years have allowed firms to constrain price rises as much as possible. Let me explain these factors in detail by households' and firms' behaviors. First, it has been taking time for wage increases to fully take hold despite labor shortage. In particular, scheduled cash earnings of regular employees, who account for the majority of total employees, have been sluggish. The year-on-year rate of increase in such earnings over the past year has remained at around 0.5 percent (Chart 4). It is said that regular employees, whose wage levels are relatively high, have a strong tendency to place priority on the stability of employment over wage increases. Such tendency still seems to be persistent, reflecting the experience of severe employment adjustments under prolonged low growth. In addition, wage developments also are affected by growing diversity in terms of worker type. From a long-term perspective, an increase in labor participation by women and seniors in recent years is essential to cope with the declining trend in the working-age population, which is a challenge for Japan's economy. In the short term, however, this increase will ease labor shortage, thereby constraining wage increases. Second, the fact that households' tolerance of price rises has not been increasing clearly has been constraining a rise in inflation. According to the Bank's survey, following the introduction of quantitative and qualitative monetary easing (QQE) in 2013, the level of households' tolerance of price rises shifted upward in a favorable direction compared to past levels. However, the level has not risen further (Chart 5). This is likely to be attributable to the first reason mentioned earlier -- that is, it has been taking time for wage increases to fully take hold. Third, firms' cautious price-setting stance also has been constraining a rise in inflation. Although wages have been rising, albeit moderately, and commodity prices such as of crude oil have been on an uptrend, firms that are concerned about possibly losing customers due to price hikes have been making efforts to absorb upward pressure of costs on prices by increasing labor-saving investment and streamlining their business process. Firms have been enthusiastic about making software investment in sectors such as "construction," "retailing," and "accommodations, eating and drinking services," where labor shortage is acute, and many firms have offset a rise in labor costs by introducing self-checkout machines and automatic ordering system (Chart 6). These efforts by firms are likely made possible through the recent progress in information technology. So far, I have talked about firms' cautious wage- and price-setting stance as well as households' cautiousness toward price rises. Such mindset and behavior can be regarded as a kind of "social mode" in Japan that has been brought about by the experience of prolonged low growth and deflation, and it is likely to have been taking time to resolve this. In addition, the effects of intensifying competition among firms cannot be ignored. For example, retailers such as supermarkets have maintained their cautious price-setting stance, reflecting in part the expansion of online shopping (Chart 7). This is the so-called Amazon Effect, which is another example of rapid progress in information technology constraining a rise in inflation. C. Why Will Inflation Rise Going Forward? Although it is taking time for inflation to rise, some changes have been seen amid the continued improvement in the economic and employment conditions that I mentioned earlier. For example, moves to raise sales prices are starting to be observed recently at a wide range of firms, mainly in the services sector, such as dining-out (Chart 8). In addition, according to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan), the number of enterprises answering that the output prices have risen has been exceeding the number of those answering that such prices have fallen for the first time in a while. As the so-called baby boomers are reaching their 70s, labor market conditions are likely to tighten further and the pace of increase in wages of mainly part-time employees is expected to accelerate. As the effects of such moves of wage increases spread to regular employees' wages, this will lead to an increase in households' tolerance of price rises. When this happens, price rises by firms will be more easily accepted. While price developments are affected by various factors that I have explained so far, the factor that determines the underlying trend in prices is the aggregate supply-demand balance. As the output gap has been maintained within positive territory -- showing excess demand -- for a long time, in reflection of economic expansion, many of the aforementioned factors that have been constraining inflation will likely be resolved gradually. If that happens, another important factor that forms the underlying trend in prices is likely to change -- that is, people's perception of prices, which means inflation expectations in a broad sense, including households' tolerance of price rises and firms' price-setting strategies. The Bank assesses such factors that determine the underlying trend in prices by using the word "momentum." If you look up "momentum" in a dictionary, it is defined as "force" or "impetus," which imply a short period of time. However, as the objective of monetary policy is achieving price stability in the long term, the Bank assesses the "momentum" in terms of a somewhat longer time frame. Specifically, it makes a comprehensive judgment as to whether the momentum is maintained by examining the main factors that determine the underlying trend in prices, such as the output gap and medium- to long-term inflation expectations, while making use of various indicators and information. In the latest Outlook Report, the Bank projects that the year-on-year rates of change in the CPI (less fresh food) for fiscal 2018 through fiscal 2020 are likely to be 1.1 percent, 1.5 percent, and 1.6 percent, respectively (Chart 9). We are in a difficult situation in terms of achieving 2 percent inflation by fiscal 2020, as it is taking more time than expected for inflation to rise. Nevertheless, the momentum whereby an improvement in the output gap leads to an increase in actual inflation, and then a rise in inflation expectations, is maintained. It is of utmost importance to sustain such positive momentum by maintaining the output gap as long as possible within positive territory, and this is likely to be the most certain path toward achieving 2 percent inflation. III. The Bank's Conduct of Monetary Policy Next, I would like to explain the Bank's conduct of monetary policy including the measures decided at the MPM held two days ago. The Bank has been pursuing powerful monetary easing under the policy framework of "QQE with Yield Curve Control," aiming to achieve the price stability target of 2 percent (Chart 10). In order to achieve the price stability target at the earliest possible time, the Bank set the target level of 10-year Japanese government bond (JGB) yields at around zero percent, and has purchased large amount of JGBs so that the yield curve would be formed in line with the target. By conducting this operation, short- and long-term interest rates have been stable at low levels and lending rates as well as issuance rates for corporate bonds -- to which certain spreads are added in both cases -- also have remained at extremely low levels. The amount outstanding of bank lending has been increasing firmly. Thus, the current highly accommodative financial conditions, brought about by yield curve control, have largely contributed to an improvement in the output gap, stimulating firms' and households' spending activities. In addition, the Bank has purchased exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) with a view to exerting positive effects on economic activity and prices through lowering risk premia in the stock market. As I explained, following the discussion at the latest MPM, the Bank released its economic projections, which show that it will take more time than expected to achieve the price stability target of 2 percent. However, the momentum toward 2 percent inflation has been maintained. Accordingly, as for the conduct of monetary policy, the Bank judged it appropriate to persistently continue with the current powerful monetary easing, thereby maintaining the output gap as long as possible within positive territory, in order to make the momentum sustainable. During the discussion, we thought it necessary to address two challenges. The first is to firmly maintain confidence among the public regarding the Bank's current policy stance that aims at achieving the price stability target of 2 percent. The second is to strengthen the sustainability of the current powerful monetary easing so that the effects of monetary easing will not be reduced while taking care of such factors as the negative effects on financial markets, in a situation where monetary easing needs to be continued. In order to address these two challenges, the Bank decided to newly implement measures to strengthen the framework of powerful monetary easing. Today, within the limited time provided, I would like to introduce particularly important measures (Chart 11). First, the Bank decided to strengthen its commitment to achieving 2 percent inflation by introducing forward guidance for policy rates. You may not be familiar with the term, but forward guidance is a measure that guides the future policy path in order to strengthen market confidence and expectations toward monetary policy. At the latest MPM, the Bank publicly committed to "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." I would like to reiterate that, even though the projected timing of reaching 2 percent inflation has been delayed, the Bank will not reduce the degree of monetary easing. Second, the Bank decided to implement several measures to enhance the sustainability of "QQE with Yield Curve Control." For example, while the target level of 10-year JGB yields is around zero percent, as I mentioned earlier, the Bank made it clear that, under the target, the long-term yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. Recently, there is a growing concern in the JGB market that the market functioning has been deteriorating, with the long-term yields being somewhat stuck and the transaction volume being on a declining trend, although this can be regarded in a sense as the consequence of powerful monetary easing. In continuing with monetary easing, the Bank judged it necessary to allow the long-term yields to move upward and downward to some extent mainly depending on developments in economic activity and prices, thereby maintaining the market functioning so as not to create more concern. However, the target level of the long-term yields remains at around zero percent. In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately. The Bank does not expect the level of yields ratcheting up. In addition, as for ETF purchases, from the same aspect of enhancing the sustainability of the current monetary policy framework, the Bank made it clear that it might increase or decrease the amount of purchases depending on market conditions, while maintaining the annual pace of increase at about 6 trillion yen. The aim of these policy measures is to strengthen the sustainability of the current powerful monetary easing, taking into account the side effects. The Bank recognizes that the effects of monetary easing will be strengthened as a whole, in consideration of this sustainability. The Bank also recognizes the risk that, by continuing such powerful monetary easing, financial institutions' strength will be cumulatively affected by low profitability, mainly through a decrease in their lending margins, and thus the functioning of financial intermediation will be stagnant. Currently, as financial institutions have sufficient capital bases and their lending attitudes continue to be active, there is no serious problem with the functioning of financial intermediation. However, there is no change in the Bank's intention that it will thoroughly examine the risks considered most relevant to the conduct of monetary policy. As a central bank, the Bank will continue conducting monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions, so that the momentum toward 2 percent inflation will be maintained and the economy thereby will grow in a balanced manner between economic expansion and price stability. Conclusion To conclude, I would like to talk about the economy of Kyoto Prefecture. Kyoto Prefecture's economy can be judged as having been expanding, even though the effects of the torrential rains a while ago can be seen in part. In Kyoto, there are a number of global manufacturers that represent Japan in sectors of electronic parts and devices as well as industrial machinery. Moreover, Kyoto attracts attention from all over the world as an international tourist destination distinguished by more than 1,200 years of history. Thus, production and exports have been on an uptrend while steadily benefiting from the growth in overseas economies, and demand from foreign visitors also has been firm on the back of an increase in foreign tourists to Japan. In addition, business fixed investment has become more active, as seen in investment intended for capacity expansion as well as research and development in the manufacturing sector and that intended for extension of accommodation facilities such as hotels in the nonmanufacturing sector. Employee income also has increased moderately. Reflecting such favorable economic conditions, labor shortage has been progressing in Kyoto Prefecture, as is the case nationwide. In this situation, active labor participation by women and seniors has been observed and labor-saving investment in various forms is becoming more dynamic. For example, a wide range of firms irrespective of sector have established sections specializing in promoting diversity and worked on creating various working systems, such as shorter and flexible working hours. As a result, some have expressed the opinion that such moves have led to an increase in female and senior workers. In addition, many firms in the eating and drinking services as well as accommodations sectors, which are underpinned by demand from foreign visitors, have been making up for labor shortage by raising productivity, such as through introducing tablet devices and making use of the Internet of Things (IoT). As I have explained today, such moves may weaken upward pressure on wages and prices in the short term, but in the longer term, they will raise the productivity of the economy as a whole, thereby strengthening its growth potential. As this potential rises, firms' spending behavior and households' consumption are likely to become more active, eventually contributing to pushing up prices. Such positive developments that have been clearly observed in the prefecture are expected to support the achievement of the 2 percent price stability target in a stable manner. In closing, let me convey my best regards and express my sincere hope that you will continue to make Kyoto even more attractive while uniting tradition and innovation for the further development of the prefecture's economy. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kyoto August 2, 2018 Masayoshi Amamiya Deputy Governor of the Bank of Japan Chart 1 Japan's Economy Length of Economic Recovery Period Unemployment Rate Corporate Profits s.a., % s.a., % Rank Period Length February 2002February 2008 73 months December 2012- 66 months November 1965July 1970 (Izanagi Boom ) December 1986February 1991 (Bubble Boom ) November 1993May 1997 (as of May 2018) Ratio of current profits to sales (all industries and enterprises) 57 months 51 months 43 months CY 86 89 92 95 98 01 04 07 10 13 16 CY 86 89 92 95 98 01 04 07 10 13 16 Note: Figures for corporate profits are based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Sources: Cabinet Office; Ministry of Finance; Ministry of Internal Affairs and Communications. Chart 2 Output Gap and Consumer Prices Consumer Prices Output Gap y/y % chg. % -1 -2 -1 -3 -4 -2 -5 CPI (all items less fresh food) -3 -6 CPI (all items less fresh food and energy) -7 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -4 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. The output gap is based on BOJ staff estimations. Notes: 2. The CPI figures are adjusted for changes in the consumption tax rate. Sources: Bank of Japan; Ministry of Internal Affairs and Communications. Chart 3 Why Is the Bank Aiming at 2 Percent Inflation? Three Reasons Upward bias in the CPI Buffer for monetary policy 2 percent as a global standard Price Stability in Advanced Economies Country/ Region Definition United States (FRB) Longer-run goal Euro area (ECB) Quantitative definition United Kingdom (BOE) Target Japan (BOJ) Price stability target Indicator Numerical expression (y/y chg.) PCE deflator 2% HICP Below, but close to, 2% CPI 2% CPI 2% Chart 4 Firms' Cautious Wage-Setting Stance Labor Force Participants Wage Increases Seniors (aged 65 and over) Women (aged 15-64) y/y % chg. change from CY 2000, mil. persons change from CY 2000, mil. persons Scheduled cash earnings (full-time employees) Population Labor force participants Labor force participants Hourly scheduled cash earnings (part-time employees) Population -1 -2 -3 -4 -1 -5 -2 -6 CY 00 -2 16 CY00 Notes: 1. Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February in the wage graph. Wage figures from 2017/Q1 onward are based on existing respondents (continuing observation) following the sample revision of the Monthly Labour Survey in January 2018. Notes: 2. Figures for labor force participants and population for 2018 are January-May averages on a seasonally adjusted basis. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 5 Households' Tolerance of Price Rises DI ("favorable" - "unfavorable"), % points -70 tolerate price rises -75 -80 -85 -90 -95 CY 07 Note: Comments on the rise in prices are chosen among three alternatives: "rather favorable," "difficult to say," and "rather unfavorable." Source: Bank of Japan, Opinion Survey on the General Public's Views and Behavior. Chart 6 Firms' Cautious Price-Setting Stance Labor-Saving Investment in Sectors Facing Acute Labor Shortage Software Investment (Tankan) Employment Conditions DI (Tankan) -70 -60 FY2005 = 100 reversed, DI ("excessive" - "insufficient"), % points "insufficient" All industries All industries Construction -50 Retailing -40 Accommodations, eating & drinking services -30 Construction Retailing Accommodations, eating & drinking services -20 -10 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 FY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Note: Figures for software investment for fiscal 2018 are based on plans in the June 2018 survey. Source: Bank of Japan. Chart 7 Intensifying Competition Online-Shopping Ratio to Total Expenditure 3.5 Interview Responses by Firms - The Bank's Regional Economic Report (Jul. 2018)- % 3.0 Since competitors have intensified their pricecutting strategies, we may also cut sales prices further in the future (a supermarket [Sendai]). 2.5 2.0 1.5 1.0 0.5 0.0 CY 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Consumers have a deep-rooted cost-saving mentality and we are losing customers to lowprice retail businesses such as drugstores and online retailers (a supermarket [Kyoto]). We are feeling the threat of other types of retail businesses that have intensified their price-cutting strategies at the expense of profits, and thus we have cut the sales prices of several hundred items, especially privatebrand products (a supermarket [Hiroshima]). Notes: 1. Figures are calculated using "total expenditure on goods and services ordered over the Internet" from the Survey of Household Economy and "consumption expenditures" from the Family Income and Expenditure Survey. 2. In the right chart, the parentheses show the industry of the interviewee and the Bank branch. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 8 Moves to Raise Sales Prices Spread of Wage Increases to Prices Output Prices DI (Tankan) y/y % chg. DI ("rise" - "fall"), % points 2.0 Eating out 1.5 Services related to domestic duties 1.0 -10 -20 0.5 -30 Large enterprises 0.0 -40 -0.5 CY 12 Small enterprises -50 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. The CPI figures are adjusted for changes in the consumption tax rate. Notes: 2. There is a discontinuity in the data of the output prices DI in the December 2003 survey due to a change in the survey framework. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 9 Outlook for Economic Activity and Prices (July 2018 Outlook Report) the medians of the Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) Fiscal 2018 +1.5 +1.1 Forecasts made in April 2018 +1.6 +1.3 Fiscal 2019 +0.8 +1.5 Forecasts made in April 2018 +0.8 +1.8 Fiscal 2020 +0.8 +1.6 Forecasts made in April 2018 +0.8 +1.8 Note: Figures for the CPI (all items less fresh food) exclude the direct effects of the consumption tax hike. Source: Bank of Japan. Chart 10 Yield Curve Control 1.4 % Recent 1.2 Bottom of 10-year JGB yields (July 27, 2016) 1.0 0.8 Target level of the long-term interest rate: 0.6 around zero percent Short-term policy interest rate: minus 0.1 percent 0.4 0.2 0.0 -0.2 -0.4 -0.6 residual maturity, year Source: Bloomberg. Chart 11 Strengthening the Framework for Continuous Powerful Monetary Easing Taking more time than expected to achieve the price stability target of 2 percent. Maintaining the output gap as long as possible within positive territory is appropriate. Persistently Continuing with Powerful Monetary Easing Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." ⇒ Strengthening the commitment to achieving the price stability target Enhancing the sustainability of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Long-term interest rate: The Bank maintains the target level of around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. Purchases of ETFs: The Bank maintains the annual pace of increase in the amount outstanding of about 6 trillion yen. While doing so, the Bank may increase or decrease the amount of purchases depending on market conditions. etc. Achieving the price stability target of 2 percent at the earliest possible time while securing stability in economic and financial conditions. 11■
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Panelist speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the BIS Symposium to mark the 20th Anniversary of the BIS Representative Office for Asia and the Pacific, Hong Kong, 15 October 2018.
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October 16, 2018 Bank of Japan Globalization and Monetary Policy Panelist Speech at BIS Symposium to Mark the 20th Anniversary of the BIS Representative Office for Asia and the Pacific (Hong Kong, October 15, 2018) Haruhiko Kuroda Governor of the Bank of Japan First of all, I would like to extend my sincere congratulations to General Manager Carstens, Dr. Remolona, Chief Representative for Asia and the Pacific, and other staff members of the BIS Asian Office on the Office's 20th anniversary. Over the past twenty years, the Asian economies have experienced significant changes, particularly improvements in resilience to external shocks. The BIS Asian Office has played an important role in these improvements, including by enhancing cooperation among central banks in the region. I will touch upon the importance of regional cooperation in promoting global monetary and financial stability later, but let me first discuss price and financial stability within individual economies under globalization. How has globalization affected price and financial stability? As we saw in the global financial crisis a decade ago, and in the Asian Financial Crisis about two decades ago, global or regional financial integration did affect domestic financial stability in many countries. While financial integration facilitates consumption smoothing and diversification of risks across countries, large and volatile capital flows carry risks for global financial stability. Compared with the effects on financial stability, what is less evident is how globalization has affected price stability. Since BIS economists, about a decade ago, proposed the hypothesis that the factors influencing domestic inflation have become increasingly global, 1 this hypothesis has attracted considerable attention. A large body of empirical studies have examined whether, and to what extent, global factors such as global economic slack and global competition have affected domestic inflation dynamics, and whether their roles have increased with global economic integration. The evidence so far, however, still seems to be inconclusive. There could be several channels through which globalization affects domestic inflation. Most obviously, movements in import prices directly affect consumer prices. Moreover, some global factors such as international competition pressure and cross-border price differentiation of multinational corporations could affect domestic prices without actual import flows. These channels may be captured by the global output gap and global markup of price over cost as additional explanatory variables in the standard Phillips curve equation, in addition to import prices. More recently, BIS economists have demonstrated that the growing 1 Borio, C. and A. Filardo (2007) "Globalisation and inflation: new cross-country evidence on the global determinants of domestic inflation," BIS Working Papers, 227. importance of global value chains might be key to explaining the influence of global factors on domestic inflation.2 The significance of these global factors has continued to be examined empirically. For a better understanding of the role of these global factors in domestic inflation, I would like to make three points here. First, there are substantial differences between countries as to how much and through which channels globalization affects domestic inflation, depending on the country's size, income level, trade openness, and so on. For instance, Japan is a large and advanced economy but has already been deeply integrated into global and regional value chains, including with emerging economies. Its domestic output gap considerably reflects foreign market conditions through net exports. Under these conditions, the additional impact of increased competition pressure from emerging economies on domestic inflation may be limited or hard to identify in the estimation of a Phillips curve equation. Second, various aspects of globalization, such as trade, competition, and value chains, may affect domestic inflation in different directions. While increased competition pressure and rising integration in global value chains have placed downward pressure on domestic inflation, there has been another recent trend toward increasing global market concentration, particularly in information and communication technology-intensive service industries, which may pose an upside risk to future inflation through rising markups.3 Third, it is important to distinguish the short-term and the long-term effects of globalization on inflation. Fluctuations in import prices have only a temporary effect on inflation, and there is little empirical evidence that the effect of global factors on the trend component of inflation has been increasing over time.4 Inflation trends in many countries have mainly been driven by domestic factors, especially long-term inflation expectations. Developments in inflation 2 Auer, R., C. Borio, and A. Filardo (2017) "The globalisation of inflation: the growing importance of global value chains," BIS Working Papers, 602. 3 Andrews, D., P. Gal, and W. Witheridge (2018) "A genie in a bottle? Globalisation, competition, and inflation," OECD Economics Department Working Papers, 1462. 4 Forbes, K. (2018) "Has globalization changed the inflation process?" Paper presented at 17th BIS Annual Research Conference on June 22, 2018. expectations are influenced by the actual inflation at short horizons, but it is generally considered that they are eventually determined by some anchor point at longer horizons. This last point leads to one answer to the question how monetary policy challenges from spillovers can be met. Better-anchored inflation expectations based on clear and credible communications by a central bank would be one way to deal with the spillover of external shocks. Of course, I understand more challenging situations faced by central banks in emerging economies that are relatively vulnerable to volatile capital flows and exchange rate fluctuations. However, as shown in the IMF's World Economic Outlook, published earlier this month,5 the anchoring of inflation expectations in emerging economies has improved significantly over the past two decades. It has also been demonstrated that further improvement in the extent of anchoring could strengthen economic resilience to external shocks, by reducing inflation persistence and limiting the pass-through of currency depreciations to domestic prices. Here I would like to briefly mention the case of Thailand, which was at the epicenter of the Asian Financial Crisis. After the crisis, Thailand moved to a floating exchange rate regime with a flexible inflation targeting framework. It then established the legal framework of monetary policy conducted by the Bank of Thailand in an independent manner. Overall, it has recorded excellent performance in price stability over the past two decades, and in recent years, the Bank of Thailand has been tackling low inflation rather than high inflation. Finally, I would like to come back to the issue of regional cooperation, which is another way for central banks to deal with the spillover of external shocks. In the East Asia and Pacific region, we have many opportunities to discuss regional economic and financial market developments. Close communication and cooperation among central banks through these opportunities would be crucial, especially in crisis times when huge external shocks could affect domestic price and financial stability. More specifically, a number of initiatives have already been established through regional cooperation to enhance the resilience of regional economies against external shocks. The Chiang-Mai Initiative Multilateralization has been established as a regional financial safety net for crisis prevention and resolution. In addition, 5 International Monetary Fund (2018) "Challenges for monetary policy in emerging economies as global financial conditions normalize," Chapter 3, World Economic Outlook, October 2018. efforts have been made to develop local currency bond markets, which are important to eliminate the double mismatches of currency and maturity which exacerbated the debt burden at the time of the Asian Financial Crisis. In one such initiative, the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP) set up the Asian Bond Fund (ABF) in 2003, and since then the BIS has worked closely together with the EMEAP on this initiative. In sum, both closer regional cooperation and better macroeconomic policy frameworks within individual economies are important ways to deal with the spillover of external shocks and thereby promote global monetary and financial stability. I would like to conclude my remarks by once again expressing my appreciation for the role the BIS Asian Office has played over the past twenty years, especially in supporting regional cooperation among central banks. Thank you very much for your attention.
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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, Akita, 11 October 2018.
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Keynote speech by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at the "Nippon no Kakushin-ryoku (Japan's Innovation)" Symposium, co-hosted by the Faculty of Economics, Keio University and Nikkei Inc., Tokyo, 25 October 2018.
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October 25, 2018 Bank of Japan The Post-Crisis World: Evolution of the Economy, Economics, and Central Banks Keynote Speech at "Nippon no Kakushin-ryoku" (Japan's Innovation) Symposium Co-hosted by the Faculty of Economics, Keio University and Nikkei Inc. Masazumi Wakatabe Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is my pleasure to speak here today at Keio University. As an alumnus and former professor at Waseda University, an opportunity like this, given the longstanding fruitful relationship between the two schools, is a great honor. Yukichi Fukuzawa, founder of Keio University, Shigenobu Okuma, founder of Waseda University, and the Bank of Japan share a long and intimate history together. The fact that Fukuzawa and Okuma were close friends is a famous story. During the Meiji Restoration, Okuma sought to lead reforms with the support of Keio's alumni but failed, only to be expelled from the government -- an incident later known as the failed Meiji-14 coup of 1881. In the following year, Okuma, emulating his friend Fukuzawa, built a school, which served as the predecessor of Waseda University. The Bank of Japan was established that very same year. Truth be told, Okuma, back when he was still a member of the government, proposed a plan for building Japan's first central bank (Bank of Japan [1982], pp.77-79). Although his plan was rejected, it is not far-fetched to consider part of his proposal as having been reflected in the Bank of Japan's charter in the form of liquidity provision. This year marks about 20 years since Japan's financial crisis and the 10th anniversary of the Global Financial Crisis triggered by the collapse of Lehman Brothers. Milestones provide us with ample opportunity to look back on the past. In my speech today, I will begin with an overview of significant changes observed in economic society today. I will then discuss the evolution of economics and the role of central banks. My message to you is threefold: first, change holds the key; second, it is important that we update our knowledge in response to change; and third, understanding the basics is essential regardless of -- or because of -- changes. I. Progress for Humankind and Challenges Ahead Before reflecting on Japan's financial crisis of about two decades ago and the Global Financial Crisis one decade ago, let me provide the even longer-term perspective of centuries ago. As the saying goes, "no news is good news" -- people tend to focus on unfavorable news including controversial incidents and natural disasters. In the long run, however, humankind has been making steady progress. The 17th century philosopher Thomas Hobbes once wrote, in his renowned work Leviathan, that "the natural condition of mankind" was "solitary, poore [sic], nasty, brutish, and short" (Hobbes [1651], Chart 1). The situation has changed drastically since then. There has been a dramatic reduction in wars, violence, famine, and diseases, and people live longer so that it is now considered reasonable to expect to live for 100 years. Poverty, although persistent, is on a declining trend from a long-term perspective (Norberg [2017]; Pinker [2011, 2018], Chart 2). What is the driving force behind these changes? First on the list are the effects of Enlightenment-based thought since the time of Hobbes as well as the development, accumulation, and spread of scientific knowledge. Economists in the 18th century such as David Hume and Adam Smith made notable contributions in these areas. Second, the market economy plays a considerable role in the development, accumulation, and spread of such Enlightenment-based thought and scientific knowledge. The so-called globalization has encouraged not only the exchange of goods and money but also the interaction between people and the sharing of knowledge. We tend to assume that, in a market economy, human relationships become cold and impersonal, based solely on profit-seeking motives, and people become overly dependent on the market. In reality, however, human motivation is complicated and diverse. The market economy in fact allows for the coexistence of various motives as long as a certain level of profit is raised. Moreover, mutual trust among people is indispensable for markets to function properly (Seabright [2010]), and further, individuals become capable of supporting themselves through market participation (Matsui [2018]). These insights are the very line of thinking that had been held by distinguished economists in previous times, such as Hume and Smith.1 Globalization too In his "Of Refinement in the Arts," Hume [1987] argues that industry and refinements in mechanical arts would sophisticate the arts and science and humanity, stating "industry, knowledge, and humanity, are linked together by an indissoluble chain" (p.271): "The more these refined arts advance, the more sociable men become…They flock into cities; love to receive and communicate knowledge; to show their wit or their breeding; their taste in conversation or living, in clothes or furniture…and the tempers of men, as well as their behaviour, refine apace." In his "History of Astronomy," Smith [1980] traces the origins of philosophical and scientific thinking to the stability of social life: "Mankind, in the first ages of society, before the establishment of law, order, and security, have little curiosity to find out those hidden chains of events which bind together the seemingly disjointed appearances of nature…But when law has established order and often is associated only with the cross-border flow of goods and money, but it is the cross-border exchange of knowledge among countless people all over the world that enables us to create new knowledge atop what already has been built and to enjoy the benefits of our lives today. Having said this, we must not presume that the future is nothing more than simply something that lies in front of us. In the short run, there is an extensive list of issues on our agenda waiting to be tackled. Progress is in fact the by-product of unwavering efforts made by humankind in order to address challenges confronted at each point in time. Put differently, failing to keep up with these efforts will result in stagnation, or even worse, retreat. Indeed, a wide range of issues, such as macroeconomic policy, stagnating productivity growth, the impact of robotics and machine learning on employment, environmental problems including climate change, income and wealth inequality, and the rise of protectionism and the so-called populism, appear to have piled up. Although Japan's economy is no longer in deflation, many people faced economic difficulties during the period of prolonged deflation up until several years ago. Financial crises are one such issue. While the market economy is built upon mutual human trust, money -- the foundation of economic transactions therein -- is also dependent on trust. Intrinsically, circulation of money requires social trust; individuals must have the confidence that money will be accepted by a third party. A free and abundant flow of money leads to economic growth through active exchanges and transactions. For example, economic growth in emerging economies has been supported by global capital inflows. At times, however, such flow of money triggers problems. When capital inflows tie in with overly optimistic growth expectations, this may cause asset prices such as land prices and stock prices to rise excessively and, ultimately, the asset price bubble to burst. In a time of an abrupt reversal in global capital flows, countries experiencing capital outflows may be forced to undergo large-scale economic adjustments. Furthermore, while developments in security, and subsistence ceases to be precarious, the curiosity of mankind is increased, and their fears are diminished. The leisure which they then enjoy renders them more attentive to the appearances of nature, more observant of her smallest irregularities, and more desirous to know what is the chain which links them all together. That some such chain subsists betwixt all her seemingly disjointed phaenomena [sic], they are necessarily led to conceive" (pp.48, 51). financial products brought the benefits of providing greater options for asset management, they also catalyzed the contagion of financial crises worldwide, as seen during the Global Financial Crisis of 2008. The prolonged economic stagnation that followed amplified people's doubts about globalization and the market economy itself.2 In addition, the data revolution, while significantly enhancing information sharing and utilization, has led to the rise of a small number of big tech companies making full use of data. This has caused voiced concerns about the increasing market power of such firms, their effects on income and wealth inequality, and protection of privacy.3 What is more, digitalization is increasing the perceived threat of cyber-attacks so significantly that some claim that the next potential financial crisis could well be triggered by cyber-attacks on global financial institutions. II. Evolution of Economics I would now like to talk about how an ever-changing economy leads to the evolution of economics. Let me introduce a satirical article about economists published in 1973. The article entitled "Life among the Econ" was written in the style of an anthropologist's study on a tribe of economists called the "Econ" (Leijonhufvud [1973]).4 In this article, the Econ live in the far north and the status of the members is determined by their skill in making elaborated "modls" (taken from "model" used in economics) of their "field" of study. But "most of these 'modls' seem to be of little or no practical use." As for the "field" of study, the "Math-Econ" is considered as ranking higher than the "Devlops," where Math-Econ and Devlops respectively refer to scholars of mathematical economics and development economics. The Devlops are ranked lower because they interact with other tribes such as the Eichengreen [2018] traces the historical relationship between economic distress -- the rise of machines, depressions, and financial crises -- and political reactions. At this year's Jackson Hole Economic Policy Symposium hosted by the Federal Reserve Bank of Kansas City, discussion was centered on the rise of big tech companies and the effects of intangible assets on the macroeconomy. https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2018 In Japan, Sawa [1982] popularized this through his short book. Polscis (political scientists) and Sociogs (sociologists), and are suspected of having given up modl-making. The article concludes, "The prospect for the Econ is bleak. Their social structure and culture should be studied now before it is gone forever." It warns of the situation of economics at the time, where economists were too focused on making unrealistic "modls" and reluctant to collaborate with those outside the field of economics. Notwithstanding whether such satire was on point at that time, the days in which it can be applied are over. Nowadays, economic research has become increasingly founded on empirical work and data science, along with the increase in computing power, spread of the Internet, accumulation of and increase in data, and development of econometric techniques (Hamermesh [2013]; Angrist et al. [2017], Chart 3). Data science methodology has been adopted actively not only in economics, but also in social sciences in general and in some fields of humanities. Through the sharing of methodologies, interaction of economics with other fields of study is being accelerated. This is not to say that economic theory has become extinct, however. In fact, there is now greater variety to economic theory, as seen in the rise and establishment of game theory and behavioral economics. We should say that the share of purely theoretical papers in economics has decreased. What came of this was the rise in popularity of so-called applied work (Backhouse and Cherrier [2017]). With the development of economics acquiring a new character of data science and applied science, the areas to which economics is applied have been expanding. The first is applications to policy making. The term "evidence-based policy making," or EBPM, has finally started to prevail in Japan, and the government is promoting EBPM as part of its administrative reform. This is a movement that requires appropriate empirical evidence in policy making. "The cost-benefit revolution" (Sunstein [2018]) is under way, in which a balancing of costs and benefits based on empirical evidence is made use of in policy making. Specifically, economics has been applied in the context of deregulation and market designs such as spectrum auction and medical resident matching programs, for example, which have started to prove successful (McMillan [2002]; Backhouse [2010]; Siegfried [2010]; Litan [2014]). Second, economics has become a common language among policymakers. Without an understanding of economics at the very least, you will have difficulty in communication, especially at meetings of the Group of 20 (G-20), central banks, and international organizations such as the World Bank and the International Monetary Fund (IMF).5 Third, economists are now working more in collaboration with other disciplines, and engaging in research and education outside economics departments, especially in business schools, law schools, and public policy schools. Economists also play an important role at big tech companies (Chart 4). For example, it is said that the latest auction theory is applied when online advertising space is sold (Athey and Luca [2018]). In sum, economics has become increasingly empirical and useful in a practical manner. Economists have been tackling the aforementioned issues facing humankind. However, this does not mean that there are no issues to be addressed in economics itself. In particular, the outbreak of the Global Financial Crisis in 2008 posed significant challenges to economists. It is reported that, when Queen Elizabeth II visited the London School of Economics and Political Science (LSE) in November 2008, she asked economists regarding the turmoil in global financial markets: "Why did nobody notice it?" The economists were not ready to comment.6 We have to admit that the outbreak of financial crises is essentially a very difficult issue to address, and predicting it is a more difficult task. Also, as behavioral economics shows, economists may sometimes have biases or make mistakes as humans. 7 This does not mean, There is room for discussion as to the extent to which economics is actually applied to policy making. See, for example, Blinder (2018). For the response sent afterwards by U.K. economists to the Queen, see http://wwwf.imperial.ac.uk/~bin06/M3A22/queen-lse.pdf Eichengreen [2009] argues that economists could not resist various "temptations" to ignore insights obtained through information economics, organizational economics, and behavioral however, that the insights gained in economics have become useless. Academic studies progress as we learn from past experiences, including failures. The accumulation of such processes leads to the selection of our knowledge; that is, our knowledge of economics is constantly being upgraded. What you learn from textbooks is a result of this selection process, forming the basic framework of the current economics. This holds great significance in your lives, to which I will return later when I talk about financial and economic education. III. Changing Role of Central Banks Central banks, operating at the intersection between the changing economy and economics, have a long history toward becoming what they are today. In fact, the concept of central banks itself has been shaped by history. Sweden's Riksbank was established in 1668, earliest among currently existing central banks, but it originally differed from central banks we are familiar with today, in that the institution's function included extending loans to the Crown to finance war (Chart 5). Central banks have changed, evolving in a process of humankind tackling economic problems that occurred thereafter, such as large price fluctuations and financial crises (Edvinsson et al. [2018]). In the course of this evolution, a number of contributions have been made by economists, from Henry Thornton, David Ricardo, Walter Bagehot, Irving Fisher, John Maynard Keynes, and Milton Friedman to those today. Having assumed my current position at the Bank of Japan, I am now better aware of the wide-ranging roles that central banks play today (Chart 6). The Bank of Japan Act stipulates that the Bank's purpose is to achieve price stability and maintain financial system stability, thereby contributing to the sound development of the national economy. To achieve this, the Bank engages in a wide range of operations, such as issuing banknotes, conducting on-site examinations and off-site monitoring of financial institutions, operation of payment and settlement systems, and coordinating with international organizations. Needless to say, conducting research and studies through the application of economics also constitutes an important central bank operation. At this point, I will briefly explain how the Bank has responded to the two trends of the data revolution and globalization. economics. See also Zingales [2013]. Starting with the data revolution, electronic payments have become increasingly common in recent years. Although the so-called cryptocurrency is termed crypto-assets among central banks, partly because of its highly speculative nature, cashless payments using, for example, credit cards, electronic money, and QR codes have continued to increase. Central banks have been paying close attention to these developments, as payment and settlement systems are crucial infrastructures. Some central banks have begun research and deliberation on the issuance of a central bank digital currency. 8 In relation to the data revolution, economic statistics play a significant role. Accurate real-time data are desired since it is required that policy decisions, especially by central banks, be made swiftly based on data available at the time (Nishimura [2012]). With regard to globalization, not only financial and economic activities, but also knowledge pertaining to policy conduct is becoming increasingly globalized through dialogue and cooperation among central banks. Japan's financial crisis from 1997 to 1998 -- preceding the Global Financial Crisis of 2008 that I mentioned earlier -- has been studied by central banks all over the world as a lesson to be learned (Chart 7). In particular, the fact that Japan, the world's second-largest economy at the time, experienced entrenched deflation and prolonged stagnation after the crisis drew the attention of policymakers and economists worldwide. Let me sum up the lessons learned from Japan's experience. First, it has become clear that an excessive rise in asset prices above fundamentals -- the emergence of the bubble economy -- and its collapse triggering a financial crisis will exert a considerable negative impact on the economy. Second, there are still discussions, however, regarding whether to tighten monetary policy as a pre-emptive measure against a rise in asset prices. Although we should not ignore asset price fluctuations completely, taking a strong measure to burst the bubble could push the economy into a serious recession. Third, in the event of a financial crisis, ex post policy response becomes extremely important. As downward pressure is Such central banks include that of Sweden, where the amount outstanding of banknotes has been decreasing rapidly, and those of some emerging and developing economies, where infrastructure for banknotes is underdeveloped. While Bordo and Levin [2017] present research from the standpoint of advocates, Cœuré [2018] and Amamiya [2018] raise issues to be considered from a central bank's viewpoint. exerted on the economy in the wake of the crisis, it will be necessary to respond with vigorous expansionary macroeconomic policies. If the response is inadequate or delayed, the economy will fall into deflation and face difficulty escaping from it. Fourth, regarding a financial crisis, however, there is no better way than to prevent it. In doing so, ex ante and ex post financial regulation -- monitoring excessive risk-taking behavior of financial institutions and setting up a resolution mechanism -- as well as macroprudential policy -analyzing and assessing systemic risk in the financial system as a whole and taking policy measures based on it -- play key roles (Wakatabe [2015], pp.142-147). Regrettably, after Japan's financial crisis, policymakers across the globe could not prevent the Global Financial Crisis. They did, however, succeed in preventing another Great Depression by taking swift and bold policy responses after the crisis.9 For example, central banks with inflation targets managed to keep their economies from falling into severe deflation even after the crisis.10 Moreover, financial authorities including central banks have proceeded globally with the development of financial regulations, so as not to repeat a disaster like the Global Financial Crisis ever again. Through these efforts, in an ever-changing economy, central banks must be vigilant and prepared for possible future financial crises at all times. IV. Promotion of Financial and Economic Education Putting all this in perspective, we could gain a good sense of the most desirable qualities and skills of people working in the financial industry. Let me start with simple examples. As the data revolution proceeds, there likely will be greater demand for those educated in Kuttner, Iwaisako, and Posen [2015] point out, "Although the United States and many European countries were also hit hard by the collapse of the housing market in the late 2000s, most responded decisively, partly because policymakers in those countries were determined not to repeat Japan's experience in the 1990s" (pp.31-32). Some economists argue that, if the 2 percent inflation target had been set in Japan during the 1990s, the subsequent deflation would not have occurred (Braun and Waki [2006]). However, since the rate of growth in total factor productivity also declined during the so-called lost two decades in Japan, it is also possible to say that there were problems on the supply side as well as on the demand side. The past recession possibly had lasting negative effects on productivity growth of the economy. The Bank of Japan has great interest in the mutual relationship between business cycles and economic growth, on which research has been progressing recently. See the Bank of Japan Research and Statistics Department [2018] and Kaihatsu et al. [2018]. science, technology, engineering, and mathematics -- the so-called STEM education. On a similar note, globalization will naturally raise demand for those with a strong command of English as a communication tool. Society as a whole, including the government, should work toward better education and research in these areas. I personally believe that the biggest advantage to learning English is that it enables you to learn about the world and reminds you to not end up as a "frog in the well that knows nothing of the great ocean" -- a Japanese proverb that describes a person who measures things only within his or her own world. In relation to learning about the world, I would like to remind you that the economy and economics have been changing significantly. Given this, education about the underlying mechanism of society and the economy will only grow in importance, so as to help students develop the capability to sense and understand such changes properly. For the financial industry to recruit qualified talents, the key lies in whether they can effectively demonstrate the advantages of working in the industry, since those with the qualities I have just mentioned are in high demand across industries. Whether or not you work in the financial industry, financial and economic literacy is necessary for everyone. In this connection, let me introduce the Central Council for Financial Services Information (CCFSI), an organization with the two main objectives of (1) providing financial and economic information to the general public and (2) supporting financial and economic education (Chart 8).11 Its secretariat office is located within the Bank of Japan's Head Office; as Deputy Governor of the Bank, I serve concurrently as a member of the CCFSI. The council, originally the Central Council for Savings Promotion, subsequently was reorganized as the Central Council for Savings Information and renamed as the CCFSI in 2001. Especially today, when it is reasonable to expect to live for 100 years, asset formation is gaining more and more importance. Here is a set of questions relating to financial and economic literacy in this regard (Chart 9). I think that some of you here today are currently studying economics. For those who have taken an introductory course in economics, this should be a piece of cake -- at least, I believe so. Take question 1, for example. This For details on the activities of the CCFSI, see https://www.shiruporuto.jp/e/. involves compound interest calculation. Compound interest calculation is a method in which interest is added to the principal sum so that interest for the following period is then earned on the principal sum plus the previously accumulated interest. With this knowledge, you may see that one would be better off starting asset building from an early stage in life and refraining from short-term transactions based on rash decisions. Let us next take question 4. This teaches you the importance of diversifying your investment portfolio. Diversifying rather than concentrating your portfolio allows you to control a certain kind of risk. By combining these two ideas, you will find an asset formation plan of investing steadily in a diversified portfolio from a long-run perspective. Basic knowledge of economics is indeed useful, but there still seems room for improvement in financial and economic literacy in Japan: The percentage of correct answers to these kinds of questions is lower than those in the United States and European countries (Chart 10). Furthermore, consumer fraud is being carried out recently in extremely artful ways, and an understanding of economics is also helpful in determining the factors behind such fraud to seek preventive measures against it (Fukuhara [2017]).12 Conclusion Today, I have elaborated on the respective changes in the economy, economics, and central banks. What they have in common are structural changes of the data revolution and globalization. You cannot avoid these changes even by choosing a STEM career. According to the findings of research conducted in the United States, compensation is high at the outset of a STEM career; however, because rapid technological change leads to skill obsolescence, there are many cases where wages of STEM workers start to level off at a certain point and they switch jobs early on their career (Deming and Noray [2018]). Even if you choose a different career, the basic knowledge I have described using the financial and economic literacy questions will still be necessary, given that you may live for 100 years. Whether or not you seek a career in the financial industry, you are required to have the motivation and curiosity to regularly update your knowledge in response to change. In concluding, let me share with you a quote from Julian Simon, an economist (Chart 11): There are various studies on the effects of financial education. See Campbell [2016] for details. The main fuel to speed the world's progress is our stock of knowledge; the brakes are our lack of imagination and unsound social regulations of these activities. The ultimate resource is people -- especially skilled, spirited, and hopeful young people endowed with liberty -- who will exert their wills and imaginations for their own benefits, and so inevitably they will benefit the rest of us as well (Simon [1995], p.27). Thank you for your kind attention. References Amamiya, Masayoshi. 2018. "The Future of Money." Speech at the 2018 Autumn Annual Meeting of the Japan Society of Monetary Economics, October 20, 2018. Angrist, Joshua, Pierre Azoulay, Glenn Ellison, Ryan Hill, and Susan Feng Lu. 2017. "Economic Research Evolves: Fields and Styles." American Economic Review: Papers & Proceedings, 107 (5): 293-297. Athey, Susan, and Michael Luca. 2018. "Economists (and Economics) in Tech Companies." NBER Working Paper No. 25064. Backhouse, Roger E. 2010. The Puzzle of Modern Economics: Science or Ideology? Cambridge: Cambridge University Press. Backhouse, Roger E., and Béatrice Cherrier, eds. 2017. The Age of the Applied Economist: The Transformation of Economics since the 1970s, Durham: Duke University Press. Bank of Japan, ed. 1982. Nippon Ginko Hyakunen-shi [The Centennial History of the Bank of Japan]. Vol. 1. (in Japanese) https://www.boj.or.jp/about/outline/history/hyakunen/hyaku1.htm/ Bank of Japan Research and Statistics Department. 2018. "[Minutes of the 7th Joint Conference Organized by the University of Tokyo Center for Advanced Research in Finance and the Bank of Japan Research and Statistics Department: 'New Developments of Macroeconomic Analysis: Interaction between Business Cycles and Economic Growth.']" BOJ Reports and Research Papers. (in Japanese) https://www.boj.or.jp/research/brp/ron_2018/ron180330a.htm/ Blinder, Alan S. 2018. Advice and Dissent: Why America Suffers When Economics and Politics Collide. New York: Basic Books. Bordo, Michael D., and Andrew T. Levin. 2017. "Central Bank Digital Currency and the Future of Monetary Policy." NBER Working Paper No. 23711. Braun, R. Anton, and Yuichiro Waki. 2006. "Monetary Policy during Japan's Lost Decade." Japanese Economic Review, 57 (2): 324-344. Campbell, John Y. 2016. "Restoring Rational Choice: The Challenge of Consumer Financial Regulation." American Economic Review: Papers & Proceedings, 106 (5): 1-30. Cœuré, Benoît. 2018. "The Future of Central Bank Money." Speech at the International Center for Monetary and Banking Studies, Geneva, 14 May 2018. https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180514_4.en.html Deming, David J., and Kadeem L. Noray. 2018. "STEM Careers and Technological Change." NBER Working Paper No. 25065. Edvinsson, Rodney, Tor Jacobson, and Daniel Waldenström, eds. 2018. Sveriges Riksbank and the History of Central Banking. Cambridge: Cambridge University Press. Eichengreen, Barry. 2009. "The Last Temptation of Risk." The National Interest. 101: 8-14. ———. 2018. The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era. New York: Oxford University Press. Fukuhara, Toshiyasu. 2017. "Kodo Keizaigaku wo Oyo-shita Shohisha Sagi Higai no Yobo ni kansuru Ichikosatsu" [A Behavioral Insight Approach to Prevent Consumer Fraud]. Research Paper Series. Central Council for Financial Services Information. (in Japanese) https://www.shiruporuto.jp/public/document/container/report6/ Hamermesh, Daniel S. 2013. "Six Decades of Top Economics Publishing: Who and How?" Journal of Economic Literature, 51 (1): 162-172. Hobbes, Thomas. 1651. Leviathan, or, The Matter, Forme, and Power of a Common Wealth, Ecclesiasticall and Civil. London: Printed for Andrew Crooke. Hume, David. 1987. Essays, Moral, Political, and Literary. Edited by Eugene F. Miller. Indianapolis: Liberty Fund. Kaihatsu, Souhei, Maiko Koga, Tomoya Sakata, and Naoko Hara. 2018. "Interaction between Business Cycles and Economic Growth." Bank of Japan Working Paper Series 18-E-12. https://www.boj.or.jp/en/research/wps_rev/wps_2018/wp18e12.htm/ Kuttner, Kenneth, Tokuo Iwaisako, and Adam Posen. 2015. "Monetary and fiscal policies during the lost decades." In Yoichi Funabashi and Barak Kushner, eds. Examining Japan's Lost Decades. London and New York: Routledge: 17-36. Leijonhufvud, Axel. 1973. "Life among the Econ." Western Economic Journal 11 (3): 327-337. Litan, Robert E. 2014. Trillion Dollar Economists: How Economists and Their Ideas Have Transformed Business. New York: Wiley. Matsui, Akihiko. 2018. Shijo-tte nan daro: Jiritsu to Izon no Keizaigaku [What is the market?: Economics of Interdependence and Dependence]. Tokyo: Chikuma Shobo. (in Japanese) McMillan, John. 2002. Reinventing the Bazaar: A Natural History of Markets. New York: W.W. Norton & Co. Nishimura, Kiyohiko G. "Market Intelligence, Market Information and Statistics in Central Banking." Keynote Speech to the Sixth Irving Fisher Committee Conference in Basel, August 29, 2012. https://www.boj.or.jp/en/announcements/press/koen_2012 /ko120830a.htm/ Norberg, Johan. 2017. Progress: Ten Reasons to Look Forward to the Future. London: Oneworld Publications. Pinker, Steven. 2011. The Better Angels of Our Nature: Why Violence Has Declined. New York: Viking. ———. 2018. Enlightenment Now: The Case for Reason, Science, Humanism, and Progress. New York: Viking. Sawa, Takamitsu. 1982. Keizaigaku towa nan daro ka [What is economics?]. Tokyo: Iwanami Shoten. (in Japanese) Seabright, Paul. 2010. The Company of Strangers: A Natural History of Economic Life. Revised edition. Princeton: Princeton University Press. Siegfried, John J., ed. 2010. Better Living Through Economics. Cambridge: Harvard University Press. Simon, Julian L., ed. 1995. The State of Humanity. Oxford: Basil Blackwell. Smith, Adam. 1980. Essays on Philosophical Subjects. Edited by W. P. D. Wightman and J. C. Bryce. Oxford: Clarendon Press. Sunstein, Cass R. 2018. The Cost-Benefit Revolution. Cambridge: The MIT Press. Wakatabe, Masazumi. 2015. Japan's Great Stagnation and Abenomics: Lessons for the World. London and New York: Palgrave Macmillan. Zingales, Luigi. 2013. "Preventing Economists' Capture." In Daniel Carpenter and David A. Moss eds. Preventing Regulatory Capture: Special Interest Influence and How to Limit It. New York: Cambridge University Press: 124-151. The Post-Crisis World: Evolution of the Economy, Economics, and Central Banks Keynote Speech at "Nippon no Kakushin-ryoku" (Japan's Innovation) Symposium October 25, 2018 Masazumi Wakatabe Deputy Governor of the Bank of Japan Leviathan (Chart 1) Thomas Hobbes (1588-1679) "the life of man, solitary, poore [sic], nasty, brutish, and short" (Chart 2) Progress for Humankind Life Expectancy World Population in Extreme Poverty (years) World Europe Americas Asia Africa (bil.) Total population Population living in extreme poverty CY 1760 CY 1820 Source: Our World in Data. (Chart 3) Evolution of Economics Percentage Distributions of Methodology of Published Articles in Economics (%) Experiment Empirical: own data Empirical: borrowed data Theory with simulation Theory CY1963 Source: Hamermesh (2013). Increased Applications of Economics (Chart 4) Number of Positions Available for Ph.D. Economists Other than economics departments Economics departments Business schools Policy schools Tech companies Notes: 1. Figures are those for the period from February to the following January. 2. Figures for tech companies represent the number of firms with job postings (each firm may offer multiple positions). Source: Athey and Luca (2018). Establishment of Central Banks Year (Chart 5) Year Riksbank (Sweden) Bank of Japan Bank of England Bank of Italy Banque de France Swiss National Bank De Nederlandsche Bank Federal Reserve System National Bank of Belgium Bank of Canada Reichsbank (Germany) European Central Bank Source: Central banks. Objectives and Operations of the Bank of Japan (Chart 6) Operations Objectives Monetary policy Prudential policy Price stability Banknotes, payments and settlements Computer systems planning and development International finance Financial system stability Research and studies Public relations Source: Bank of Japan. (Chart 7) Japan's Experience Japan's Real Economic Growth and Inflation 8.0 Nominal Economic Growth by Country (yoy, %) 6.0 4.0 Global Bubble's Japan's Financial bursting financial Crisis crisis Real economic growth rate Inflation rate (CY1991=100) United States United Kingdom France Germany 2.0 0.0 -2.0 -4.0 FY 1981 Japan Prolonged deflation CY Note: Inflation rates are based on the CPI (less fresh food, adjusted for changes in the consumption tax rate). Sources: Cabinet Office; Ministry of Internal Affairs and Communications; International Monetary Fund; Bank of Japan. History of the CCFSI (Chart 8) Transition to Meet the Needs of the Times Year Name Characteristics 1952- Central Council for Savings Promotion National movements to control inflation after WWII and to promote savings for capital accumulation 1988- Central Council for Savings Information Stress on disseminating information relating to savings 2001Current Stress on supporting independent consumers Central Council for and on promoting financial education at schools, Financial Services Information amid financial innovations Source: Central Council for Financial Services Information. Financial Literacy Questions (Chart 9) Q1. Suppose you put 1 million yen into a savings account with a guaranteed interest rate of 2% per year. How much would be in the account after 5 years? Q2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? More than today, exactly the same, or less than today? Q3. When compared, a 15-year mortgage typically requires higher monthly payments than a 30year loan, but the total interest paid over the life of the loan will be less. True or false? Q4. Buying a single company's stock usually provides a safer return than a stock mutual fund. True or false? Q5. If interest rates rise, what will typically happen to bond prices? Will they rise, stay the same, or fall? Source: Central Council for Financial Services Information, "Financial Literacy Survey: 2016 Results." (Chart 10) Percentage of Correct Answers to Financial Literacy Questions Comparison with the U.S. (%) Comparison with European Countries (%) Japan United States Japan Germany United Kingdom Note: The average percentage of correct answers to five questions. Comparisons with the U.S. and with European countries are based on different sets of questions, respectively (For this reason, the figures for Japan differ). Source: Central Council for Financial Services Information, "Financial Literacy Survey: 2016 Results." Simon (Chart 11) The main fuel to speed the world's progress is our stock of knowledge; the brakes are our lack of imagination and unsound social regulations of these activities. The ultimate resource is people -- especially skilled, spirited, and hopeful young people endowed with liberty -- who will exert their wills and imaginations for their own benefits, and so inevitably they will benefit the rest of us as well.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the 2018 Autumn Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 20 October 2018.
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October 20, 2018 Bank of Japan The Future of Money Speech at the 2018 Autumn Annual Meeting of the Japan Society of Monetary Economics Masayoshi Amamiya Deputy Governor of the Bank of Japan （English translation based on the Japanese original） I. Introduction It is a great honor to have this opportunity to deliver a speech at the Japan Society of Monetary Economics. Today's topic is "The Future of Money." Indeed, this topic is now gaining great attention and being lively discussed among various entities, due to on-going IT innovation, global developments of various cashless payment means including mobile payments, the emergence of crypto-assets and the idea of central bank digital currency. Money is the core of financial services and economic society, and central banks were born to play a key role in the fundamental infrastructure regarding money. Accordingly, thinking about the future of money inevitably makes us reconsider the future of financial services, the economy and central banks. Moreover, as we can see with the global "data revolution" behind the recent developments of cashless payments, the future of money is closely linked to how information and data will be used in economic society in the coming era. In this speech, please allow me to use the word "money" as a general term covering various payment and settlement means, and which is not limited to central bank money and bank deposits. II. The Function of Money Money and Credit Before going into the issues regarding the future of money, I would like to touch upon the origin and fundamental function of money. Money is undoubtedly one of the greatest inventions of humans, comparable to "language" or "fire." Money enabled people to exchange goods and services across space and over time, and to build an economic society. Indeed, it would have been extremely difficult for humans to barter goods or services without using money, since such direct exchanges can only be implemented by a "double coincidence of wants." Economics textbooks describe the three functions of money as "a measure of value," "a store of value," and "a medium of exchange," and credit is the foundation of all of them. Money can perform these functions because people believe that all other people will accept money in the future. Humans became able to share such intangible credit with unknown others by building a "chain of trust," and with that built an economic society. Until now various materials such as sea-shells and pieces of metals had been used. The core value of money, however, does not lie in the utility of its materials. If the material of money itself has use value, it would be consumed without being circulated, and would not function as money. Yap Island's famous stone money, known as Rai or Fei, was difficult to find any value in its use. Moreover, it was difficult to even carry around huge stone money. Indeed, Yap Island's people found value in the stone money not in the utility of its materials, but in the "information" or "story" embedded in the stone money. By looking at the stone money, Yap people imagined how hard it had been to carve out and transport it. Yap people even found value in stone money which had sunk to the bottom of the sea as the ship transporting it was shipwrecked. They trusted the story of the hard work and the tragic shipwreck, and traded using the stone money which they had never seen but believed to be lying at the bottom of the sea. This case vividly illustrates that the functions of money lie in credit. Money and Information Processing From the perspective of information processing, money has transformed the value of various goods and services with "prices" by its common units, and enabled price mechanisms to function effectively. Indeed, money is indispensable to the concept of "general prices" and "inflation." The measure of value in a barter transaction remains to be a relative value between individual goods and services, such as "1 kg of meat for 10 kg of rice." The invention of money made it possible to denominate all the goods and services by a single unit of value, and aggregate the measured value of them in a standardized methodology. As such, money has made information processing regarding various economic activities significantly more efficient. The creation of money was definitely one of the main drivers that enabled humanity to build an economic society. The cases of hyperinflation in recent history always led to extreme malfunctioning of the economies, because hyperinflation destroyed people's "chain of trust" and price mechanisms, and thereby made information processing through money extremely inefficient. However, if many different types and units of money circulate in the economy, people would need to assess the credibility of each issuer, determine whether they could accept it or not, and agree with each other on the exchange rates between multiple numbers of units at each transaction, accordingly the efficiency of information processing would be substantially impaired. Central banks, being assigned the duty of issuing banknotes as the single issuer, were established to overcome such turmoil. The Establishment of Central Banks and "a Two-Tiered System" In order for central banks to obtain sufficient credibility to function as a single issuer of banknotes, many conditions must be fulfilled, such as establishing an institutional framework to make them sufficiently credible. Central banks therefore, were born after modern national states were established which is where these conditions were likely to be met. Indeed, the history of many central banks is less than 200 years old. Some central banks, such as the Riksbank in Sweden and the Bank of England in the United Kingdom, were born in late 17th century. These central banks, nevertheless, originally performed the functions that were close to those of commercial banks, and they were only gradually transformed into modern central banks. For example, the Bank of England, which was born in 1694, was exclusively assigned the role of issuing banknotes by the Bank Charter Act in 1844, 174 years ago, and it became the model of modern central banks. From the perspective of the supply of money, the establishment of modern central banks has led to a two-tiered system, which consists of the central bank and commercial banks. In this system, the central bank exclusively supplies the public the central bank money or base money (i.e. banknotes and central bank deposits), and commercial banks provide deposits through credit creation based on the base money. This two-tiered system has various advantages regarding information processing and resource allocation. This is why almost all countries in the world have adopted this system, although it has only been 200 years since modern central banks were established. As the central bank exclusively issues base money using a single sovereign unit, people no longer carry the burden of evaluating and converting multiple units of currency. At the same time, commercial banks contribute to efficient allocation of financial resources to the economy through their financial intermediation by private-led initiatives. Furthermore, as credit creation by commercial banks reflects funding needs and economic conditions, the supply of broad money can be flexibly adjusted to some extent. Commercial banks' credit creation and maturity transformation could sometimes become a risk to financial stability. Indeed, deposit insurance and central banks' lender of last resort (LLR) functions are needed because of commercial banks' maturity transformation. Some in academia proposed the idea of "narrow banking," which virtually prohibits commercial banks' credit creation and maturity transformation. Despite these arguments, almost all countries in the world have so far maintained the above-mentioned two-tiered system. This fact seems to prove that the advantages of the two-tiered system are still greater than its disadvantages. III. IT Innovation and Digitization of Payment Instruments Digitized Payment Instruments Under the two-tiered system, private entities, including banks, have developed a range of innovative payment instruments, incorporating the available technologies of the time. For example, credit cards and debit cards allow their users to make and settle payments by submitting instructions to transfer deposits held in banks. Card users therefore do not have to carry around large amounts of cash. Another example is electronic money. People can charge a certain amount in mediums of electronic money such as IC cards, and thereby avoid making small cash payments every day. Electronic money has particularly developed in Japan. Furthermore, digitized payment instruments based on the liabilities of non-banks have developed along with the popularization of e-commerce. A typical example is PayPal developed in the United States. The Global Expansion of Cashless Payments Today with rapid IT innovation, cashless payments, especially mobile payments, are growing on a global scale. I would like to point out two big changes behind this. First, the number of people using mobile phones or smartphones has sky-rocketed recently. Since the birth of the iPhone in 2007, smartphones have rapidly spread across the globe in just a decade. According to an estimate by the World Bank Group, around two-thirds of the 1.7 billion unbanked adults in the world have access to mobile phones or smartphones. This change has promoted the rapid growth of mobile payments, especially in emerging and developing economies. In some countries such as China, the share of mobile payments is greater than that of traditional means of retail settlements. A mobile payment does not require bricks and mortar branches or ATMs to provide financial services. Instead it uses digital information technology to reach out to emerging and developing economies and provide financial services globally through leapfrogging physical infrastructure. As such, digital technologies are also gathering much attention as a great instrument to promote "financial inclusion." The other change is the global "data revolution." Indeed "fintech" can be understood as a financial aspect of the on-going data revolution. People around the world are creating a gigantic amount of data every second by using smartphones for SNS posting, browsing websites and issuing location data through playing games in their daily lives. Some estimate that over 90 percent of the data produced in the history of humanity have been created in the last two years alone. Data processing capabilities have also improved substantially. The importance of data is increasing in a wide range of economic activities and businesses, and it is becoming a new asset which can create added value. In such an environment, cashless payments are gathering great attention as platforms to collect and utilize a variety of data associated with economic transactions. Many data-giant companies known as BigTechs, which have grown rapidly in recent years, are starting to provide cashless payment services with a view to collecting and utilizing big-data. Crypto-Assets and Central Bank Digital Currencies Meanwhile, we have also witnessed the emergence of new mediums, that is, "virtual currencies" or "crypto-assets." After the birth of the first crypto-asset, "bitcoin" in 2009, there has been a torrent of newly issued crypto-assets. Nowadays there seems to be around 2,000 types of crypto-assets. Crypto-assets have the following common characteristics: they use "distributed" types technologies such as blockchain and distributed ledger technology (DLT), they do not have a specific issuer, and they are not denominated in sovereign currency units such as yen, dollar and euro. Recently, there are proposals in academic and international forums that central banks should also utilize new technology and issue digital currencies which could be used as alternatives to banknotes. Some central banks are now seriously considering whether they should issue such digital currencies. For example Sweden, where the use of banknotes is rapidly decreasing, and some emerging and developing countries, where the infrastructure supporting banknotes has not yet fully developed, are now making extensive studies about the issuance of central bank digital currencies. IV. The Future of Money Now, the question arises as to how money will evolve in the future. In view of the rapid pace of technological progress and the drastic change in the environment surrounding payments, settlements, financial services and the economy, it would be difficult for anyone to predict how money will evolve in the future. Bearing such constraints in mind, I dare to present my own views on the future of money for discussion, and I will be touching upon the fundamental nature and functions of money discussed in the previous sections. I would like to summarize my remarks into five key messages. Credit in Money and Crypto-Assets First, it seems unlikely that crypto-assets, without a particular issuer and not being denominated in sovereign currency units, will be widely used for payments and settlements, as long as sovereign currencies maintain their credibility and utility. Whatever the forms future money takes, money continues to depend on people's credit, as in the case of Yap stone money. Building such credit will incur certain costs. In the case of Yap stone money, the costs were the efforts to carve out the stones and transport them across the ocean (sometimes in a storm). As for sovereign currencies, the institutional framework to ensure central bank independence, as well as the track record of credible policy conduct and operations, play key roles in maintaining the credibility of central banks and sovereign currencies. Once people lose trust in the central bank, even sovereign currencies are not acceptable, as evidenced in the cases of hyperinflation. As long as people's trust in the central bank is firmly maintained, the central bank is able to issue sovereign currencies for its liabilities at low marginal costs. To make crypto-assets more acceptable for payments and settlements than sovereign currencies, they need to compete with the trust that exists in central banks. However, to build trust from scratch, crypto-assets need to bear substantial costs associated with mining, which requires a huge amount of calculation and electricity. It would not be easy for crypto-assets with such constraints to be widely used for daily payments and settlements. Indeed, crypto-assets are now mainly purchased as speculative investments and are rarely used for daily payments and settlements. However, the background technologies behind crypto-assets, such as blockchain and DLT, may have great potential. If these technologies are successfully combined with the existing trust and credit of sovereign currencies, they could contribute to enhancing the efficiency of economic transactions and payments. In this regard, many central banks have embarked on research and experiments of these new technologies. The Bank of Japan has also engaged in the joint DLT-related research "Project Stella" with the European Central Bank. Further Progress Toward a Cashless Society Second, unlike crypto-assets, digital payment instruments denominated in sovereign currency units will continue to expand, leading to the further promotion of "cashless" payments. As any payment instrument, including cash, has strong "network externalities," it is difficult to argue that new digital payment instruments will become widely used instead of cash in the very near future. Especially in countries where cash is already widely used, it would take time for digital payment tools to overwhelm cash and to be widely used instead. Moreover, especially in countries with low interest rates, strong demand for cash for the storing of value could persist, and consequently the outstanding amount of cash in circulation would not decrease despite the growth of cashless and digitized payment instruments at the transaction level. While the pace of progress varies across countries and regions, the general trend of the growth of cashless and digitized payment instruments is expected to continue, due to the following reasons. First, as the core value of money rests with credit and not with its materials, money does not have to take the form of physical metal or paper. In the Yap Islands, even the invisible stone money deep down in the ocean functioned as money. It is therefore not surprising to find that digitalized data without physical form can function as money. Paper, which has been widely used as the material of money, is undoubtedly one of the greatest inventions of humanity, in a sense that it can "record," "convey," and "display" information and data (hence paper has been widely used as a medium of money and securities). These days however, information and data can now be recorded and conveyed through digital technologies, and displayed on smartphones and PC screens more easily. Second, along with technological innovation and the developments of digital trade, cashless payments have already improved people's daily lives in many aspects. For example, the spread of e-money train cards and ETC cards has substantially eased congestion at ticket vending machines and toll gates in Japan. There are various hurdles in the process of transitioning from cash to digital payment instruments. Nonetheless, once people come to realize the benefits of digital payment instruments, such as eliminating the need to queue for payments, people will never come back to cash, and the movement from cash toward digital payments can be accelerated. Third, data, as the "oil of the 21st century," is increasing in its importance, as new assets which can create added value, digital payment instruments, are now gaining great attention also in this respect. Indeed, digital payment instruments are able to record and convey much more data and information than paper attached to economic transactions. In this regard, the data revolution itself may also become the driving force for promoting cashless payments. Money and Data are Getting Closer Third, money and data will become more interlinked and closer to each other. Most economic transactions are accompanied by payments and settlements. Digital payment instruments, unlike cash, can carry much more detailed data such as who buys what, when and where. Now many giant IT firms, known as BigTechs, have embarked on providing cashless payment services at low cost or sometimes for free. These firms tend to use payment services as a platform to collect big data, and utilize these data for a variety of businesses. In such businesses, users provide their own data, instead of paying monetary fees, in exchange for the use of these services. Likewise, firms which offer discounts to customers using e-commerce or loyalty cards, virtually purchase their data. Customers, who use these rewards to purchase a variety of goods and services, exchange their own data for money-like purchasing power. As the development of cashless payments accelerates the accumulation and utilization of customer data, money and data will be more and more interlinked and become closer to each other. The advancement of digital information technologies enables digital money to serve as a medium of exchange of information and data. Indeed, digital payment instruments can store and convey various types of information and data, and which are not limited to value data. On the other hand, for the users of digital payment instruments, how to ensure privacy and anonymity is becoming a big challenge. In such an environment, money in the future will be required to strengthen its function to manage or limit the data and information attached to it, reflecting merchants' and customers' requests. For example, firms are now trying to collect useful customer information by offering discounts or rewards to customers who newly acquire loyalty cards, or provide additional information such as their age, hobbies and other characteristics in e-commerce transactions. As such, various companies will continue making efforts to collect customer information through providing economic incentives when payments or settlements are being made. On the other hand, customers will require digital payment instruments to protect their rights and privacy by separating sensitive data or limiting the use of it. Also, stronger links between money and data are expected to influence the economy and financial structures in various ways. For example, global IT innovation and data revolution have enabled firms to have the opportunity to purchase customer data through offering discounts and rewards. Since these discounts and rewards are usually subtracted from the sales prices of goods and services, IT innovation and data revolution might work as downward forces to general prices measured by traditional statistics in many countries. Also, commercial banks have so far been providing both payment services and credit intermediation services by making use of deposits as a core. On the other hand, IT firms and e-commerce firms, which have newly entered financial services, provide a variety of services including financial ones, by making use of big data and platforms for collecting data as a core. As such, stronger links between money and data are expected to alter the structure for providing financial services. Firms and individuals, which are users of financial services, can be regarded as bundles of information and data. Firms provide their own information and data, regarding their strength and the risks and returns of their businesses, to financial institutions, and then receive financial services such as loans. As such, financial services are inherently a series of information processing. IT innovation will encourage financial service providers to function also as "information banks" or "data banks," which keep customers' data and information, protect it, and make effective use of it to provide the best possible services to satisfy customers' needs. Also in this respect, financial service providers are more required to take appropriate measures for protecting data security and privacy for customers. Moreover, recently more and more non-bank entities have entered financial services. They often provide their own liabilities as payment instruments. Financial authorities are now asked to consider how they should monitor and deal with these non-bank entrants, and what kind of frameworks should be prepared for them. This issue is ultimately linked to the issue of how to define banks. Rationales of Two-Tiered System Fourth, the two-tiered system consisting of the central bank and private entities such as commercial banks will be maintained. Regarding the debates on central bank digital currencies, some in academia see their benefits also in terms of overcoming the zero lower bound of nominal interest rates, in addition to their enhancing the efficiency of economic transactions and their payments. Moreover, some argue that if central bank digital currencies completely replace demand deposits issued by commercial banks, deposit insurance and central banks' lender of the last resort functions may become unnecessary, since commercial banks will not perform the function of maturity transformation any more. They believe that the issuance of central bank digital currencies would contribute to financial stability. In this respect, such arguments are very similar to the idea of "narrow banking" proposed decades ago. Nonetheless, there remain many issues to be assessed before evaluating whether the issuance of central bank digital currencies could contribute to enhancing the effectiveness of monetary policy and financial stability. Regarding the effectiveness of monetary policy, if we want to overcome the zero lower bound of nominal interest rates, we need to completely eliminate cash. Even if we lower the interest rates on central bank digital currencies below zero, the fund shift from them into cash will occur as long as cash is used. Nonetheless, if the central bank abolishes cash, which is widely used, it would make payment and settlement infrastructures inconvenient. Moreover, cash has its own resiliency as a payment instrument, since it does not rely on the electricity supply. Indeed, cash was effectively used even during the large-scale blackout on the island of Hokkaido which was caused by the earthquake in September. Since the central bank's duty is to contribute to economic society by providing efficient infrastructure for payments and settlements, abolition of cash at this stage is not an option. Also, the central bank needs to carefully consider the possible impacts of central bank digital currencies on financial stability and financial intermediation, especially if they could substitute for not only cash but also bank deposits. For example, if the central bank issues its own digital currencies to the general public and makes them accessible through mobile instruments, stresses in the banking system might cause a "digital bank run," in which people move their funds from deposits to central bank digital currencies. In cases of traditional bank runs, depositors physically come to bank branches to withdraw their deposits. On the other hand, in the situation of digital bank runs, since people can easily move their funds without even go to a bank branch, liquidity problems could accelerate very rapidly. Moreover, if central bank digital currencies replace not only cash but also bank deposits, they could squeeze banks' credit intermediation and influence the supply of credit to the economy. In other words, the issuance of central bank digital currencies could make the existing two-tiered system into a single tiered system if they replace bank deposits. Nonetheless, a single tiered system may have disadvantages, especially in terms of the allocation of financial resources to support economic growth led by private initiatives. We may need to consider this issue also from the viewpoint of effective use of information and data. In the current two-tiered system, the central bank does not obtain the detailed data attached to people's daily transactions. In other words, the use of those data is primarily at the disposal of private entities. Meanwhile, the central bank can obtain the data necessary for maintaining overall payment and settlement stability through operating large-value payment systems. In this regard, if the issuance of central bank digital currencies transforms the current two-tiered system into a single tiered system, it could also influence the private sector's use of information and data attached to payments and settlements. Also, from the perspective of efficient use of information and data related to payments and settlements, the current two-tiered system consisting of the central bank and private entities may have some advantages and rationales. The Bank of Japan does not have a plan to issue its own digital currency that can be widely used for payments and settlements at this juncture. Meanwhile, there are some central banks which are seriously considering whether they should issue digital currencies. According to their official statements they see the potential value of central bank digital currencies for enhancing the efficiency of transactions or providing risk-free payment instruments to the general public. None of them aims to replace bank deposits with central bank digital currencies. Viewing also these developments, I think that the current two-tiered system, which is based on the central bank and private entities, is likely to be maintained even with the progress of digitization, although the characteristics of private entities may change. The Roles and Functions of Central Banks Fifth, even if digitization progresses, and cashless payments become more widely used, monetary policy and the lender of last resort functions of central banks are likely to remain effective. First, let me elaborate on the possible impacts of cashless payments on monetary policy. One imaginable case is that crypto-assets, which are not denominated by sovereign currency units, become widely used for daily payments and settlements instead of domestic sovereign currencies. Theoretically, this situation is similar to "dollarization," where foreign currencies are widely used instead of domestic currencies, and the effectiveness of monetary policy could be substantially impaired. Nonetheless, crypto-assets are unlikely to be widely used for daily payments and settlements, as previously discussed. The second case is that cashless payment instruments are issued as the liabilities of banks or they issue instructions to transfer bank deposits. In this case, the effectiveness of monetary policy may not be impaired. Indeed, there have emerged many payment instruments in this category such as checks and credit cards, but the effectiveness of monetary policy has not substantially been affected by them. The third case is that non-banks, which are different from incumbent banks, provide their liabilities denominated in sovereign currency units as payment instruments for wider use. Indeed, payment instruments in this category are growing rapidly worldwide, as shown in the cases of AliPay and WeChatPay in China and M-Pesa in Kenya. These instruments are similar to cases in which non-bank entities provide large-scale netting services. There are several new issues regarding these instruments. For example, the growth of these new instruments might cause fluctuations in velocity of monetary aggregates, which are the sum of banks' liabilities in principle, and further destabilize the relationship between monetary indicators and economic activities. Moreover, financial authorities and central banks will be required to consider how they should monitor the activities of these non-bank entrants in payment and settlement services in order to maintain payment, settlement and financial stability. Nonetheless, these issues are manageable, at least theoretically, through the review and refinement of statistics, institutional frameworks and the way to conduct monetary policy. In sum, the possible impacts of cashless payments on monetary policy are manageable, and monetary policy will remain effective in the era of digitization. Also the lender of the last resort function of central banks will still be needed if the current two-tiered system is maintained, and private entities continue playing the role of maturity transformation. Moreover, as long as domestic sovereign currencies are widely used for payments and settlements, central banks' provision of sovereign currencies would continue to be effective in alleviating liquidity problems. At the same time, due to the recent increase in new entrants, the players in payment and settlement services have become much more diversified than before. In these environments, central banks are required to consider how they should work with them and monitor their activities, in order to maintain payment, settlement and financial stability. In addition, more data are being accumulated by financial businesses, and various new instruments, such as mobile phones and tablets, are now used to access financial services. The tactics of cyber-attacks are becoming increasingly sophisticated. In these environments, it is becoming more important to take sufficient measures in terms of data security and resiliency against cyber-attacks. Central banks are required to deal with these issues in an appropriate manner. V. Closing Remarks This is my current "best effort" to predict the future of money. I would like to summarize my prediction as follow. Although it is very unlikely that crypto-assets are widely used for payments and settlements, digitized cashless payment instruments will continue to grow and be more widely used. In accordance with such a trend of digitizing payments, money will also play a greater role as a medium of information and data. The link between money and data will be strengthened further, and the closer link between them will influence the structure of financial services and the economy. Meanwhile, the two-tiered system consisting of the central bank and private entities will be maintained, and monetary policy and the lender of last resort function of central banks will remain effective. Having said that, I have one important reservation. The views I have just shared with you will probably only last for two to 30 years at the most. There is no clear scientific basis for the maximum duration of 30 years, but some in academia argue that the "technological singularity" will occur in 2045, which is 27 years later from now. Unfortunately, I do not have sufficient knowledge to determine the adequacy of this specific figure. What I would like to emphasize here by referring to this figure is the astonishing speed of IT innovation. In 2008, which was only a decade ago, we were in the midst of the global financial crisis. At that time neither crypto-assets nor blockchain existed. Devices like iPhone and Kindle, as well as businesses in the sharing economy, were still in their very early stages. Neither the "Like button" of Facebook nor Instagram had yet to appear. Since then the number of smartphones has sky-rocketed. During this decade IT firms such as "GAFA" of the United States and "BATJ" of China have grown very rapidly, are now top global firms in terms of market capitalization, and are now also entering the financial business. No one in 2008 could surely have expected these developments. Now, smartphone apps, digitized books, the "Like button" of Facebook and "instagramable" photos are deeply embedded in people's daily lives, but all of them have developed very rapidly within this decade. In view of these developments, it would be safer to expect that the changes in the coming 10 years would be more rapid and drastic than those that have occurred in the last 10 years. How will the advances of quantum computing and artificial intelligence change financial services, the economy and society in the future? To address this question, we need to continue our efforts to keep up with fast and on-going innovation and evolution. As a thought experiment, we can even imagine the case in which money will no longer be needed in the distant future, where dramatic progress in the capacity and networks for processing information and data enable people to directly and instantly agree on the exchanges of needed goods and services, and also to secure the execution of these agreements. Needless to say it may not be realistic to expect that money will disappear in the near future, since there remain many uncertainties in the economy. Meanwhile, in the history of humanity, money has always played a key role in information processing in the economy. Now the on-going IT innovation and data revolution are influencing money in various ways. In view of these developments, we can be sure that the future of money is closely linked with the future of finance, and the utilization of information and data in the overall economy in the future. From an academic perspective, money, finance and monetary economics are now at a very dynamic stage. Indeed, many new phenomena are arising from complicated interactions between money, finance, information technologies and data revolution. In these environments, I am very much interested in watching how research and studies on money and finance will develop in the coming years. The Bank of Japan, in close cooperation with academia, will continue to closely follow the development of money and finance, and take appropriate measures if necessarily. Thank you for your attention.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 5 November 2018.
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November 5, 2018 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 a distinguished gathering of business leaders in the Chubu region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with various activities of the Bank of Japan's Nagoya Branch. At the Monetary Policy Meeting (MPM) held last week, the Bank updated its projections for Japan's economic activity and prices through fiscal 2020 and released them in the October 2018 Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to explain the Bank's outlook for Japan's economic activity and prices as well as its thinking behind the recent conduct of monetary policy, while outlining the Outlook Report. I. Economic Developments Let me start by talking about economic developments. Japan's economy is expanding moderately, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. The real GDP has been on an increasing trend, albeit with fluctuations, and the output gap -- which shows the utilization of capital and labor -widened within positive territory from late 2016, for seven consecutive quarters through the April-June quarter of 2018 (Chart 1). Under such circumstances, the duration of the current economic recovery phase, which began in December 2012, is likely to have reached 69 consecutive months this August. If this recovery continues, its duration in January next year will exceed the longest post-war recovery phase of 73 months. Now, I would like to explain in detail the current situation of Japan's economy by demand component. First, with regard to external demand, let me take a look at the underlying developments in overseas economies. According to the latest World Economic Outlook (WEO) released by the International Monetary Fund (IMF) recently, the annual real GDP growth rates for 2018 and 2019 are both projected to be 3.7 percent (Chart 2). The projections for each year were revised downward by 0.2 percentage point from the previous ones released three months ago, and differences in growth rates among regions have widened to some extent. Thus, the synchronous growth of the global economy that was observed a while ago has been changing to some extent. However, the main scenario is maintained, in which the global economic growth rate is expected to remain close to the peak after the global financial crisis, in the range of 3.5-4.0 percent, and a virtuous cycle of economic activity has continued to operate on the whole. Looking at developments by region, the U.S. economy has maintained its strong growth due in part to the effects of tax reductions, and the European economy has continued to recover, although its growth pace has decelerated somewhat. The Chinese economy has continued to see stable growth on the whole, although the pace of increase in fixed asset investment has slowed recently. As for the outlook, the Chinese economy is likely to broadly follow a stable growth path as policy authorities conduct fiscal and monetary policy in a flexible manner, although it is expected to be affected to some extent by the United States having raised tariffs imposed on China. Other emerging economies have been recovering moderately on the whole. Under such developments in overseas economies, Japan's exports have maintained their increasing trend, led mainly by capital goods and IT-related goods, in which Japan has a comparative advantage. On this point, I heard from firms in the Chubu region, which is one of the biggest production sites and export bases of machine tools in Japan, that they have continued to receive solid orders on the whole, mainly from the United States and Europe. Next, I will turn to domestic demand. First, in the corporate sector, profits have followed their improving trend, and business sentiment has stayed at a favorable level, albeit with fluctuations stemming from natural disasters. In this situation, business fixed investment has continued on an increasing trend (Chart 3). In the manufacturing sector, there have been notable increases not only in investment intended for domestic capacity expansion but also research and development investment in anticipation of such developments as changes in market structures. I heard that automobile-related firms in this region have been actively proceeding with advancing next-generation technology such as that concerning self-driving systems and electric vehicles. In the nonmanufacturing sector, investment aimed at improving efficiency and saving labor in order to deal with the recent labor shortage has maintained its high growth nationwide. Such improvement in the corporate sector has had positive effects on the household sector. In the labor market, the active job openings-to-applicants ratio has been at a high level that exceeds the peak of the bubble period, and the unemployment rate has declined to around 2.5 percent (Chart 4). The number of employees has registered a year-on-year rate of increase of around 2 percent, and total cash earnings per employee have risen moderately but steadily. Against the background of such improvement in the employment and income situation, private consumption has been increasing moderately, albeit with fluctuations. Let me now talk about the outlook for Japan's economy. The Bank projects that the economy is likely to continue its moderate expansion. In the Outlook Report released last week, the real GDP growth rate for fiscal 2018 is projected to be 1.4 percent, and this is clearly above Japan's potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. As for fiscal 2019 and 2020, the real GDP growth rates are both projected to be 0.8 percent (Chart 5). The economy is expected to continue on an expanding trend, partly supported by external demand, although the growth pace is projected to decelerate, due mainly to a cyclical slowdown in business fixed investment and the effects of the scheduled consumption tax hike. There are, of course, upside and downside risks to this baseline scenario of the outlook for Japan's economic activity. In particular, uncertainties regarding overseas economies appear to have heightened recently. Of these uncertainties, the consequences of recent protectionist moves, including the trade friction between the United States and China, warrant attention, and an active exchange of views regarding this issue took place at the Group of Twenty (G-20) meeting held in Indonesia last month. As was discussed at the meeting, the impact of protectionist policies on the global economy varies, largely depending not only on the direct effects of downward pressure on trade activity but also the extent to which it spreads to firms' fixed investment stance and global financial markets. According to simulation analyses related to this issue by some international organizations, the degree of impact varies to some extent depending on the assumptions. Meanwhile, the Bank judges that the impact on Japan's economy has been limited so far, mainly based on the recent Tankan (Short-Term Economic Survey of Enterprises in Japan) and interviews with firms. However, firms have voiced that it is difficult to accurately gauge the potential impact at this point. In addition to this, if protectionist moves last for a long time, we will need to pay attention to the possibility that their effects on Japan's economy will become more significant through the various channels that I mentioned earlier. Needless to reiterate, protectionist policies will not benefit any economy. Therefore, a brake is expected to be put on excessive protectionist moves at some point. In fact, positive progress was seen recently in trade negotiations between the United States and Canada, Mexico, Europe, and Japan. While the focus will be on developments in negotiations between the United States and China for the time being, the Bank will thoroughly examine the consequences of protectionist moves and their effects on Japan's economy. In addition, risk factors originating from overseas economies have been pointed out. These include the possibility of such moves as policy rate hikes in the United States leading to capital outflows from emerging economies, the possibility of the United Kingdom being driven into the so-called no-deal Brexit, and various geopolitical risks including those of the Middle East. Taking account of these various risks, stock markets of various economies have continued to see large fluctuations since mid-October, triggered by a significant fall in U.S. stock prices (Chart 6). The favorable economic fundamentals of Japan as well as the United States and Europe have not changed substantially, and other financial markets such as the foreign exchange and government bond markets have been relatively calm. However, as uncertainties regarding overseas economies have heightened, it is necessary to carefully monitor future developments, including those in investors' sentiment and corporate profits. II. Price Developments Now I will move on to price developments. The year-on-year rate of change in the consumer price index (CPI) has continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and that excluding fresh food and energy prices has been at around 0.5 percent (Chart 7). This is likely to be attributable to two main factors (Chart 8). First, the experience of prolonged low growth and deflation has had a substantial impact on people's sentiment (Chart 9). For instance, according to a survey conducted by the government, the significant reasons why firms do not pass on cost increases to sales prices despite rises in personnel expenses and prices of raw materials are that they wish to maintain relationships with business partners and consumers and are concerned about reductions in sales volumes. What lies behind this likely is that people's tolerance of price rises has decreased, due mainly to the effects of prolonged deflation. In order to ease this cautious stance toward price rises, households' income situation needs to improve. While there seems to be a need on the firms' side to keep sufficient funds on hand considering the experience of past low growth and the financial crisis, if household income does not increase, consumers' perception of price rises will not improve readily. As a result, firms' sales and profits will not increase either. With tightening labor market conditions, wages of part-time employees have continued to register relatively high growth. However, in order to clearly change firms' and households' sentiment and resolve the situation where prices are stalling, a rise in wage growth rates as a whole will continue to be an important key. The second reason for a rise in inflation taking time is changes in the business environment for those supplying goods and services, including firms' efforts toward improving productivity, the technological progress in recent years that promotes such efforts, and an increase in labor participation by women and seniors. Such factors have allowed firms to avoid raising prices, even amid cost increases resulting from the economic expansion. To avoid any misunderstanding, let me add that such efforts are expected to lead to strengthening the growth potential of the economy as a whole, and are favorable for Japan's economy. On the price front, a rise in future growth expectations also is likely to make firms' and households' spending behavior more active, thereby contributing to pushing up prices in the long term. At least in the short term, however, these moves will weaken upward pressure on wages and prices. So far, I have explained the reasons why prices do not rise easily. In fact, prices in Japan have continued to show relatively weak developments compared to the economic expansion. On the other hand, however, the economy is no longer in deflation, in the sense of a sustained decline in prices. The year-on-year rate of increase in the CPI (all items less fresh food) has continued to accelerate, albeit with fluctuations. Although there is still a long way to go to achieve the price stability target of 2 percent, the year-on-year rate of change recently has risen to around 1 percent, which is about half the target (Chart 10). A driver for such a rise in inflation is improvement in the output gap. As I mentioned at the beginning, Japan's output gap has widened within positive territory for seven consecutive quarters. As written in economic textbooks, prices of goods and services rise when demand exceeds supply. In addition, as economic activity becomes more dynamic, it is likely that labor market conditions will tighten and wage growth rates will rise more clearly. Under these circumstances, it is expected that households' tolerance of price rises will improve, and along with this, firms' stance gradually will shift toward further raising prices. In fact, looking at developments in the output prices DI in the Tankan, the situation recently has taken hold in which the proportion of enterprises answering that the output prices have risen exceeds the proportion of those answering that such prices have fallen, for the first time in about 30 years since the bubble period. Thus, as firms' and households' cautious sentiment changes and further price rises come to be observed widely, on the back of the positive output gap, the year-on-year rate of change in the CPI is likely to increase gradually toward the price stability target of 2 percent, in line with a rise in inflation expectations. Specifically, in the latest Outlook Report, the year-on-year rates of change in the CPI (less fresh food) are projected to be 0.9 percent for fiscal 2018, and excluding the effects of the scheduled consumption tax hike, 1.4 percent and 1.5 percent for fiscal 2019 and 2020, respectively (Chart 11). As is the case with economic activity, there are various uncertainties regarding the pace of inflation going forward. Maintaining a positive output gap -- a driver for a rise in inflation -- for as long as possible, which will firmly push up actual prices as well as inflation expectations, is likely to be the most certain path toward achieving 2 percent inflation. III. The Bank's Conduct of Monetary Policy I have explained economic activity and prices in Japan thus far. I would now like to talk about the Bank's conduct of monetary policy. The Bank has been conducting powerful monetary easing under the framework of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control." In terms of yield curve control, with a view to facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent, the Bank has conducted large-scale purchases of Japanese government bonds (JGBs) under the guideline for market operations, in which it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent (Chart 12). As I mentioned earlier, in order to achieve the price stability target of 2 percent, it is important to maintain a positive output gap -- a driver for a rise in inflation -- for as long as possible. To this end, it is necessary to persistently continue with the current powerful monetary easing. Based on this recognition, the Bank decided at the July 2018 MPM to enhance the sustainability of the policy as follows (Chart 13). First, the Bank introduced forward guidance for policy rates. This is a measure that clarifies its policy stance of continuing with powerful monetary easing by making clear future policy rates in advance. Specifically, the Bank publicly made clear to "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." Second, the Bank decided to conduct market operations and asset purchases in a more flexible manner as an adjustment to continue with powerful monetary easing going forward. For example, while the target level of the long-term yields was maintained at around zero percent, the Bank made it clear that the actual yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. With the Bank's large-scale JGB purchases continuing, their side effects, such as rigid JGB yields and a decline in transactions, have been pointed out in the market. As interest rate formation becomes more flexible and the degree of market functioning improves reflecting the latest policy response, this consequently will lead to enhancing the sustainability of the current policy. About three months have passed since the policy decision was made, and its effects have already been observed. According to surveys mainly on economists conducted in the meantime, there has been a significant decline in the number of respondents holding the view that the Bank will raise policy rates in the near future. This shows that the Bank's thinking has been clearly communicated to market participants through the introduction of forward guidance (Chart 14). In addition, in the JGB market, both spot and futures transactions have become somewhat more active, and day-to-day price movements have been increasing to some extent since the policy decision was made at the July MPM. In the first half of this year, there had been a situation where JGB yields hardly responded to changes in stock prices and U.S. long-term interest rates, but the price linkage of these markets has been recovering. Thus, the degree of market functioning has improved with the Bank conducting JGB purchases in a flexible manner (Chart 15). Regarding the effects brought about by powerful monetary easing, its relation to financial institutions' profits and the functioning of financial intermediation is often discussed. The Bank fully recognizes that, by continuing such monetary easing, financial institutions' strength will be cumulatively affected by low profitability, mainly through a decrease in their lending margins, and that it could have an impact on financial system stability as well as the functioning of financial intermediation. That is, if financial institutions become more active in risk taking to secure profits amid the low interest rate environment and severe competition continuing, the financial system could destabilize should large negative shocks actually occur in the future. Meanwhile, prolonged downward pressure on financial institutions' profits under the continued low interest rate environment could create a risk of a gradual pullback in financial intermediation, partly through making them reluctant to lend. These points are analyzed in detail in the Bank's Financial System Report released twice a year. Although these risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases, the Bank will make efforts to grasp the latest situation through its on-site examinations and off-site monitoring of financial institutions and encourage them to take concrete actions as necessary. In addition, as mentioned in the latest Outlook Report, it is necessary to pay close attention to future developments regarding these risks and side effects, from the viewpoint of conducting monetary policy as well. Over the past five years, Japan's economy has clearly improved. Corporate profits have been at record highs, and the employment situation has improved substantially. Prices have improved steadily compared to five years ago, when the economy was suffering from deflation. Japan's economic activity and prices are no longer in a situation where decisively implementing a large-scale policy to overcome deflation was judged as the most appropriate policy conduct, as was the case before. However, it has been taking time to achieve the price stability target of 2 percent. In such a situation where economic and price developments have been somewhat varied, it has become necessary to persistently continue with powerful monetary easing while considering both the positive effects and side effects of monetary policy in a balanced manner. Going forward, the Bank will examine the risks considered most relevant to the conduct of monetary policy and conduct its policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. Conclusion Lastly, I would like to conclude my speech by touching upon the economy of the Tokai region. The region has always been the frontrunner of economic recovery in the current recovery phase. Production in the regions' manufacturing sector has recovered to a level exceeding that seen immediately before the global financial crisis, and moves toward expanding investment also have been spreading in the nonmanufacturing sector with support from the financial side, as seen in infrastructure-related investment for railways and airports as well as in newly opened large retail stores. As for the outlook, large-scale projects, such as next-generation cars facing a "once-in-a-century transformational period" and the Linear Chuo Shinkansen scheduled to start operating in 2027, will continue to be carried out in anticipation of what society will be like a decade or two from now. Although you must all be familiar with this already, it is essential to pay attention to various risks and take precautions in order for the economy of the Tokai region to maintain steady growth. On this point, many firms in this region have made progress with optimizing production sites at the global level since the global financial crisis. Such long-term efforts will likely function effectively as a countermeasure against protectionist moves, which are gradually developing into a somewhat significant risk. In addition, a number of natural disasters, such as typhoons and earthquakes, have occurred this year. Although supply chains in the Tokai region also were partly damaged, the negative impact was dealt with relatively quickly. I heard that this has been the successful result of steady efforts made in the past few years toward the so-called visualization of supply chains, based on the experience of the Great East Japan Earthquake. While it may not be appropriate to treat it in the same way as the aforementioned risks, as a positive output gap is maintained and labor market conditions continue to tighten, labor shortage eventually may be a significant constraint on corporate activities. In order to overcome this situation well, so that firms keep growing, how to secure talented human capital, including from the wage side, will be a more important challenge than ever before. Although it may have been risky under deflation to take actions ahead of others, the situation already has changed. I hope that corporate managers in this region will dispel the mindset and behavior that is based on the assumption of deflation and continue to take initiative in their leading roles within Japan's economy. I would like to close my speech today by making a commitment that the Bank will persistently continue with powerful monetary easing, thereby providing its utmost support for such initiative. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagoya November 5, 2018 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Economic Developments Japan's Economy Real GDP Output Gap s.a., ann., tril. yen % Excess demand -2 -4 -6 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -8 CY 85 Excess supply Note: The output gap is based on BOJ staff estimations. Sources: Cabinet Office; Bank of Japan. Chart 2 I. Economic Developments Overseas Economies and Exports Projections for Major Economies (IMF) Real Exports y/y % chg., % points World 3.3 Advanced economies United States 1.7 1.6 3.7 2.3 2.2 Euro area 1.9 2.4 Japan 1.0 1.7 4.4 4.7 6.7 6.9 Emerging market and developing economies China ASEAN-5 4.9 5.3 Projection Projection 3.7 3.7 (-0.2) (-0.2) 2.4 2.1 (0.0) (-0.1) 2.9 2.5 (0.0) (-0.2) 2.0 1.9 (-0.2) (0.0) 1.1 0.9 (0.1) (0.0) 4.7 4.7 (-0.2) (-0.4) 6.6 6.2 (0.0) (-0.2) 5.3 5.2 (0.0) (-0.1) s.a., CY 2015=100 CY 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Note: The post-2018 figures in the left table are based on October 2018 WEO projections. Figures in parentheses show the differences from the July 2018 projections. Sources: IMF; Ministry of Finance; Bank of Japan. Chart 3 I. Economic Developments Corporate Profits and Business Fixed Investment Business Fixed Investment Plans (September Tankan) Corporate Profits s.a., % s.a., ann., tril. yen Ratio of current profits to sales (all industries and enterprises, left scale) Private nonresidential investment (SNA, real, right scale) y/y % chg. ▼R&D investment FY ＋ 2.9 y/y % chg. ＋ 3.3 Business fixed investment (including land purchasing expenses) -5 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -10 -15 -20 FY 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Notes: 1. Figures for ratio of current profits to sales are based on the Financial Statements Statistics of Corporations by Industry, Quarterly (from 2009/Q2 exclude "pure holding companies"). Excluding "finance and insurance." Notes: 2. Figures for business fixed investment (including land purchasing expenses) and R&D investment are based on the plans as of September Tankan in each fiscal year (all enterprises). Sources: Ministry of Finance; Cabinet Office; Bank of Japan. Chart 4 I. Economic Developments Employment and Income Situation Labor Market Conditions s.a., ratio Active job openings-to-applicants ratio (left scale) Unemployment rate 1.6 (right scale) 1.8 Nominal Wages s.a., % y/y % chg. 1.4 1.2 -1 -2 1.0 Special cash earnings (bonuses, etc.) -3 Non-scheduled cash earnings -4 Scheduled cash earnings 0.8 Total cash earnings 0.6 0.4 CY 80 -5 -6 Note: In the right chart, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 5 I. Economic Developments BOJ's Forecasts of the Real GDP (October 2018 Outlook Report) s.a., ann., tril. yen Fiscal 2020 +0.8% Fiscal 2018 (y/y % chg.) +1.4% Fiscal 2019 +0.8% FY 12 Note: Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Cabinet Office; Bank of Japan. Chart 6 I. Economic Developments Developments in Financial Markets Volatilities of Stock Prices Stock Markets 25,000 yen points 3,000 40 points Nikkei 225 Stock Average 120 (Nikkei VI) Nikkei 225 Stock Average (left scale) 2,900 yen/U.S. dollar S&P 500 (VIX) S&P 500 (right scale) 24,000 Foreign Exchange Markets Yen/U.S. dollar 2,800 23,000 2,700 22,000 2,600 21,000 Yen depreciation 2,500 20,000 19,000 Sep. 2,400 2,300 Dec. Source: Bloomberg. Mar. June Jun. Sep. Yen appreciation Sep. Dec. Mar. Jun. June Sep. Sep. Dec. Mar. June Jun. Sep. Chart 7 II. Price Developments Consumer Prices y/y % chg. -1 CPI (all items less fresh food) CPI (all items less fresh food and energy) -2 CY 10 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 8 II. Price Developments Reasons for a Rise in Inflation Taking Time Mindset Experience of prolonged low growth and deflation Supply Side Large room for firms to raise productivity Technological progress in recent years High wage elasticity of labor supply The pace of improvement in prices and inflation expectations has remained slow compared to the improvement in the output gap. 1. Firms' cautious wage- and price-setting stance 2. Sluggish increase in households' tolerance of price rises 3. Intensifying competition Chart 9 II. Price Developments Factors related to Mindset Reasons for Not Passing On Cost Increases to Sales Prices Households' Tolerance of Price Rises Firm prioritizes long-term relationships with business partners and consumers Firm keeps sales prices until competitors raise prices DI ("favorable" - "unfavorable"), % points Tolerate price rises Firm fears large reduction in sales volume Firm absorbs the rise in costs by reducing other costs -5 Business partners hold initiative to set prices Firm is constrained by contracts with business partners Other (includes characteristic information) Employment, income, economy -10 Prices Comments on the rise in prices Firm varies product quality and quantity % -15 CY 07 08 09 10 11 12 13 14 15 16 17 18 Notes: 1. Figures in the left chart are based on a survey of 3,030 listed and 2,970 non-listed firms conducted by the Cabinet Office (2013). Notes: 2. In the right chart, comments on the rise in prices are chosen among three alternatives: "rather favorable," "difficult to say," and "rather unfavorable." Estimation is done using effective Notes: 2. samples in which all the relevant questions for the estimation were answered. Figures show deviations from the displayed period average. Sources: Cabinet Office (2013), "Annual Report on the Japanese Economy and Public Finance 2013"; Bank of Japan. Chart 10 II. Price Developments Environment Surrounding Prices Output Gap and Prices % Output Prices DI (Tankan) y/y % chg. DI ("rise" - "fall"), % points Large enterprises Output gap (left scale) CPI (less fresh food, right scale) -2 -1 -4 -2 -6 -3 Small enterprises -10 -20 -8 CY 85 -4 -30 -40 -50 CY 85 Notes: 1. The CPI figures are adjusted for changes in the consumption tax rate. The output gap is based on BOJ staff estimations. Notes: 2. There is a discontinuity in the data of the output prices DI in December 2003 due to a change in the survey framework. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 11 II. Price Developments BOJ's Forecasts of the CPI (October 2018 Outlook Report) y/y % chg. 2.0 Fiscal 2019 +1.4% CPI (all items less fresh food) 1.5 Fiscal 2020 +1.5% Fiscal 2018 (y/y % chg.) +0.9% 1.0 0.5 0.0 -0.5 -1.0 FY 12 Note: Figures are adjusted for changes in the consumption tax rate. Forecasts are the medians of the Policy Board members' forecasts excluding the effects of the scheduled consumption tax hike (point estimates). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 12 III. The Bank's Conduct of Monetary Policy Yield Curve Control % 1.2 Recent JGB yield curve 1.0 0.8 Target level of the long-term interest rate: around zero percent 0.6 0.4 Short-term policy interest rate: minus 0.1 percent 0.2 0.0 -0.2 -0.4 residual maturity, year Source: Bloomberg. Chart 13 III. The Bank's Conduct of Monetary Policy Strengthening the Framework for Continuous Powerful Monetary Easing (Decided on 31 July, 2018) Taking more time than expected to achieve the price stability target of 2 percent. Maintaining the output gap as long as possible within positive territory is appropriate. Persistently Continuing with Powerful Monetary Easing Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." ⇒ Strengthening the commitment to achieving the price stability target Enhancing the sustainability of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Long-term interest rate: The Bank maintains the target level of around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. Purchases of ETFs: The Bank maintains the annual pace of increase in the amount outstanding of about 6 trillion yen. While doing so, the Bank may increase or decrease the amount of purchases depending on market conditions. etc. Chart 14 III. The Bank's Conduct of Monetary Policy Forecasts for the Target Level of the Long-Term Interest Rate Weighted Averages (End of 2018 and 2019) 0.3 Distribution (End of 2019) % number of respondents July 2018 survey End of 2019 August 2018 survey End of 2018 0.2 September 2018 survey October 2018 survey 0.1 0.0 Dec. Feb. Apr. June Aug. Oct. survey period -0.1～ 0.0～ 0.0 0.1 0.1～ 0.2 0.2～ 0.3 0.3～ 0.5 0.5～ 0.75～ 0.75 1.0 % Source: JCER, "ESP Forecast." Chart 15 III. The Bank's Conduct of Monetary Policy Functioning of the JGB Markets Transaction Volume in the JGB Markets JGB Yield Elasticity to U.S. Long-Term Interest Rates tril. yen elasticity to rise in U.S. long-term interest rates by 1bp, bps (1) Introduction of QQE with a Negative Interest Rate (2) Introduction of QQE with Yield Curve Control (3) Decision of Strengthening the Framework for Continuous Powerful Monetary Easing 0.25 0.20 0.15 0.10 0.05 CY 13 Transaction volume in the JGB markets 6-month backward moving average 0.00 Average from CY 2016 to 2017 -0.05 Jan. July Jul. Jan. July Jul. Jan. July Jul. Notes: 1. Transaction volume in the left chart is the gross amount purchased by banks, investors, and bond dealers. Notes: 2. Figures in the right chart are slopes in a simple regression model (90-day backward rolling regression) in which the dependent variable is daily changes of 10-year JGB yields and the explanatory variable is daily changes of 10-year U.S. Treasury yields (one-period lag). Shaded areas indicate ±1 standard error bands. Sources: Bloomberg; JSDA.
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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, Kochi, 7 November 2018.
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November 7, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kochi 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 overseas economies. The business sentiment of manufacturing firms on a global basis has maintained its improving trend, although it recently has deteriorated somewhat, and the world trade volume has continued to recover. In this situation, overseas economies have continued to grow firmly on the whole. In terms of the outlook, overseas economies are expected to continue growing firmly on the whole. According to the October 2018 World Economic Outlook released by the International Monetary Fund (IMF), the global growth rate is projected to be 3.7 percent in both 2018 and 2019. Looking at developments by major region, the U.S. economy has been expanding. The European economy has continued to recover, although its growth pace has decelerated somewhat. The Chinese economy has continued to see stable growth on the whole. Other emerging economies and commodity-exporting economies have been recovering moderately on the whole, reflecting in particular an increase in exports and the effects of those economies' stimulus measures. As for the outlook, the U.S. economy is expected to keep expanding and the European economy is projected to continue recovering. The Chinese economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner. Other emerging economies and commodity-exporting economies are likely to continue their moderate recovery on the whole. Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the U.S. macroeconomic policies and their impact on global financial markets, (2) the consequences of protectionist moves and their effects, (3) developments in emerging and commodity-exporting economies, including the effects of the two factors I just mentioned, (4) negotiations on the United Kingdom's exit from the European Union (EU) and their effects, and (5) geopolitical risks. Uncertainty is particularly high regarding future developments in trade policies worldwide, and therefore these developments warrant attention. I hold the view that it is important to stay vigilant regarding these risk factors, especially now that overseas economies are continuing to grow firmly on the whole. B. Japan's Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan. The economy is expanding moderately, with a virtuous cycle from income to spending operating. The real GDP growth rate registered minus 0.9 percent for the January-March quarter of 2018 on an annualized quarter-on-quarter basis, and thereafter marked 3.0 percent for the April-June quarter, which was above the economy's potential growth rate.1 While the contribution of net exports on real GDP growth has remained slightly negative, that of domestic demand has turned positive. With regard to the outlook, Japan's economy is likely to continue its moderate expansion. In fiscal 2018, the economy will probably continue growing at a pace above its potential. Namely, 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, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending. In Kochi Prefecture, given the favorable situation in domestic demand, various measures have been taken such as events to commemorate the 150th anniversary of the Meiji Restoration, and it is expected that these events will increase tourist numbers. In terms of Japan's exports, these are expected to continue their moderate increasing trend, with overseas economies expected to grow firmly on the whole. In fiscal 2019 and 2020, Japan's economy is expected to continue on an expanding trend although the growth pace is projected to decelerate due to a slowdown in domestic demand, reflecting the effects of the scheduled consumption tax hike, cyclical adjustments in capital Under a specific methodology, Japan's potential growth rate is estimated to be in the range of 0.5-1.0 percent. 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. stock, and Olympic Games-related demand peaking out.2 According to the October 2018 Outlook for Economic Activity and Prices (hereafter the Outlook Report) released by the Bank of Japan, the medians of the Policy Board members' forecasts of the economic growth rate are 1.4 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020. 2. Prices Let me now explain price developments. Although the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is at around 1.0 percent, it has continued to show relatively weak developments compared to the economic expansion and labor market tightening, remaining at around 0.5 percent excluding the effects of energy prices. With regard to the outlook, medium- to long-term inflation expectations are projected to rise gradually as firms' stance is likely to gradually shift toward further raising wages and prices with the output gap remaining positive. As a consequence, the year-on-year rate of change in the CPI (all items less fresh food) is likely to increase gradually toward 2 percent. 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 October 2018 Outlook Report are 0.9 percent for fiscal 2018, and, excluding the direct effects of the scheduled consumption tax hike, 1.4 percent for fiscal 2019 and 1.5 percent for fiscal 2020.3 It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers. Policies concerning the provision of free education are also factored into the forecasts, based on information available as of October 2018. Assuming that the rise in the consumption tax will be fully passed on to prices of taxable items, excluding those to which a reduced tax rate will be applied, the effect of the October 2019 consumption tax hike on the year-on-year rate of change in the CPI (all items less fresh food) for October 2019 onward is estimated to be 1.0 percentage point; the effect for fiscal 2019 and 2020 is estimated to be 0.5 percentage point for each year. It also is assumed that the effects of policies concerning the provision of free education will not be reflected in the CPI, as statistical treatment of these effects is not yet decided. II. Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I would like to discuss several points that I think deserve particular attention in terms of realizing the outlook for economic activity and prices that I mentioned earlier. A. Supply-Demand Conditions in the Labor Market and the Income Situation Let me first talk about supply-demand conditions in the labor market and the income situation. As the economy has continued its moderate expansion, the output gap has widened within positive territory; the figure for the April-June quarter of 2018 -- the most recent data available -- was about 2 percent. Furthermore, supply-demand conditions in the labor market have continued to tighten steadily. The year-on-year rate of increase in the Labour Force Survey-based number of employees has been at around 2 percent, and against this backdrop, the active job openings-to-applicants ratio has been at a level that exceeds the peak marked during the bubble period. Moreover, a perception of labor shortage suggested by the employment conditions diffusion index (DI) in the Tankan (Short-Term Economic Survey of Enterprises in Japan) has heightened, and the unemployment rate has been around 2.5 percent recently. These indicators of supply-demand conditions in the labor market show that the degree of labor market tightness has been at around the level last seen in the first half of the 1990s or in the first half of the 1970s. In terms of the outlook, as Japan's economy is likely to continue on a growing trend at a pace above its potential, it is expected that the number of employees will keep increasing and that the supply-demand conditions in the labor market will continue to tighten steadily. Amid such supply-demand conditions in the labor market, the year-on-year rate of increase in hourly scheduled cash earnings of part-time employees, which are responsive to supply-demand conditions in the labor market, has exhibited relatively high growth of around 2.0 percent on average. On the other hand, the year-on-year rate of increase in scheduled cash earnings of full-time employees has remained at around 0.5 percent. As a result, although total cash earnings per employee have been increasing moderately, albeit with fluctuations, the increases have remained relatively weak compared to the labor market tightening, partly due to the high wage elasticity of labor supply in recent years, mainly among women and seniors. With regard to the outlook, overall employees' hourly cash earnings are projected to increase moderately at almost the same pace as labor productivity growth in nominal terms, and their rate of increase is expected to accelerate thereafter. However, there is a risk that firms will remain cautious with their decisions on wage setting, and in this context, I am paying attention to their stance regarding wages going forward. B. Prices Next, I will turn to price developments, taking into account supply-demand conditions in the labor market and the income situation. The year-on-year rate of change in the CPI (all items less fresh food and energy) has remained at around 0.5 percent. There are likely to be two main factors behind such weak developments. One is that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households, due mainly to the experience of prolonged low growth and deflation. The other is that the room to raise productivity and the technological progress have allowed firms to absorb a rise in labor costs by increasing labor-saving investment and streamlining their business process, and thereby constrain price rises. On the other hand, although the pace of improvement in prices has remained slow, some changes have been seen amid the improvement in the economic and employment conditions. For example, moves to raise sales prices are starting to be observed at a wide range of firms, mainly in the services sector. According to the Tankan, the number of enterprises answering that the output prices have risen has been exceeding the number of those answering that such prices have fallen. Also, with the aging of the population, labor market conditions are likely to tighten further and the pace of increase in hourly scheduled cash earnings of part-time employees is expected to accelerate. In addition to such moves, if full-time employees' wages increase with an improvement in productivity, this will lead to an increase in households' tolerance of price rises. While price developments are affected by various factors, I consider that the factor that determines the underlying trend in prices is the aggregate supply-demand balance. As the output gap remains positive, various factors behind the weak developments in prices will likely be resolved gradually. If that happens, firms' wage- and price-setting stance and households' tolerance of price rises will improve, and the pace of increase in inflation expectations will accelerate gradually. III. Conduct of Monetary Policy Let me now turn to the Bank's monetary policy. The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and has been conducting monetary policy to achieve this target at the earliest possible time. To this end, the Bank has been pursuing powerful monetary easing, considering developments in economic activity and prices, as well as financial conditions, under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control introduced in September 2016. The Bank, under this framework, has been conducting yield curve control, in which it controls short- and long-term interest rates. Specifically, at present, according to the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. By conducting this operation, short- and long-term interest rates have been stable at low levels, and I consider that the highly accommodative financial conditions, brought about by yield curve control, have contributed to an improvement in the output gap by stimulating firms' and households' spending activities. Meanwhile, prices have continued to show relatively weak developments compared to the economic expansion and labor market tightening. Following the discussion at the Monetary Policy Meeting (MPM) held on July 30 and 31, 2018, the Bank released its economic projections, which showed that it would take time to achieve the price stability target of 2 percent. It also judged that, while the momentum toward 2 percent inflation had been maintained, it was necessary to persistently continue with powerful monetary easing, thereby maintaining the output gap within positive territory for as long as possible. Based on this judgment, the Bank decided at the MPM to implement measures to strengthen its commitment to achieving the price stability target and to enhance the sustainability of QQE with Yield Curve Control. This set of measures consists of two major components. The first is the introduction of forward guidance for policy rates. Forward guidance is a measure that guides the future policy path in order to strengthen market confidence and expectations toward monetary policy. The Bank announced in its July policy statement that it "intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." In consideration of these uncertainties and the price developments, the Bank will not reduce the degree of this powerful monetary easing for an extended period of time. The second component is the implementation of several measures to enhance the sustainability of QQE with Yield Curve Control. For example, the Bank, while maintaining the target level of 10-year JGB yields at around 0 percent, made clear that the yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. I believe that allowing the long-term yields to move to some extent will, in a broad sense, lead to maintaining market functioning. Meanwhile, it should be noted that the Bank does not intend to raise the level of yields -- this means that, in the case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately. In addition, as for exchange-traded fund (ETF) purchases, from the same aspect of enhancing the sustainability of the monetary policy framework, the Bank made it clear that it might increase or decrease the amount of purchases depending on market conditions, while maintaining the annual pace of increase at about 6 trillion yen. The Bank also recognizes the risk that continuing powerful monetary easing will cumulatively affect financial institutions' strength, mainly through a decrease in their lending margins, and thus the functioning of financial intermediation will be stagnant. The Bank intends to continue paying careful attention to the risks considered most relevant to the conduct of monetary policy. With a view to achieving the price stability target of 2 percent, the Bank will continue conducting monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. IV. Challenges for Japan's Economy I would now like to express my thoughts regarding the current situation for Japan's economy from a longer-term perspective. According to the Bank's estimates, the potential growth rate has been in the range of 0.5-1.0 percent recently. Although the rate has risen compared to around 2010, it can be said that Japan's growth potential has been sluggish. That said, as initiatives toward structural reforms and a growth strategy proceed among a wide range of entities, I consider that the boost in the country's growth potential would be accelerated through the rise in productivity. Looking at corporate activities, it has been a couple of years since the output gap turned positive. Although it differs by industry, firm size, and other factors, supply-side constraints have been the bottleneck in firms' growth on the whole. In this situation, mainly on the back of improved profits, firms have started to increase fixed investment aimed at expansion in supply capacity of products and services: firms often start to review their business strategy when planning fixed investment and can improve productivity through such efforts. At the same time, firms have been making plans for development of new high value-added products and services by increasing research and development investment. Moreover, firms have been taking various measures that reflect demographic changes and tight labor market conditions, on which I now would like to elaborate using five examples. The first is effective use of employees through initiatives including working-style reforms. In Japan, inefficiency borne from the lack of streamlining and the practice of working long hours are common; in my view, there is still considerable room to enhance work efficiency through such initiatives. The second is women's participation in the economy. In Japan, the labor force participation rate of women in the working-age population has reached 70 percent, which is considered a high level on a global standard. I expect that this trend will encourage firms to assign more women to value-added work and promote them to managerial positions from now on. The third is employment of seniors. Although their employment has been progressing, there remains considerable room for improvement, as there are gaps between what they can accomplish through their ability and will, and what they actually are assigned to do. The fourth is employment of foreigners. Although their employment has been increasing gradually, it is still vital to further develop systems to accept them. Lastly, the fifth example is labor-saving efforts through utilization of information technology including the use of robots. Japan is a leading country in robotics, and I believe that we should expand its application from manufacturing operations to other kinds of work, including administrative work. As these initiatives toward structural reforms and a growth strategy bring about benefits including improvement in business efficiency, they may exert downward pressure on wage increases in the short term, but in the longer term, they will raise the productivity of the economy as a whole, thereby strengthening its growth potential. I believe that improving productivity would stimulate price rises through increases in wages and private consumption. Nevertheless, even now there are firms that maintain their cautious wage- and price-setting stance, as they are concerned, for example, about a shrinking of the domestic market size and the issue of succession for businesses; they also lack confidence in growth in private consumption. Let me note that raising productivity and growth potential is a time-consuming task. Therefore, while the Bank's conduct of monetary policy stimulates aggregate demand and suitably tight supply-demand conditions are being maintained, a virtuous cycle in which active demand encourages progress in various initiatives should remain intact for a long period of time. I believe that, with a view to achieving its price stability target and realizing sustainable economic growth in a coordinated manner, the Bank should continue with its monetary easing policy and firmly support the various initiatives taken by a wide range of entities.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2018 Paris Europlace International Financial Forum, Tokyo, 19 November 2018.
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November 19, 2018 Bank of Japan Demographic Changes and Challenges for Financial Sector Remarks at the Paris EUROPLACE Financial Forum in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor for me to have the opportunity once again to give a speech at the Paris Europlace Financial Forum. Among the many occasions I was invited to this Forum in the past, I talked about financial innovation in the last two years. This year, I would like to talk about another long-term issue faced by many advanced economies; namely, demographic changes. Among advanced economies, France has led the way in tackling the issues brought about by declining population. The total fertility rate has been gradually increasing; however, it continues to face the challenges of an aging population. Meanwhile, Japan faces the headwinds of both a declining and an aging population, with a total fertility rate far below two.1 Today, I would like to talk about how such demographic changes are affecting the financial sector. I. Demographic Changes, Economic Growth, and Interest Rates First, let us consider the impact of a declining and aging population on economic growth. If the population is declining and aging at the same time, the working-age population decreases. Since a reduction in the working-age population means a decrease in labor input, this leads to a slowdown in economic growth. Even when the total population is increasing, a decrease in the proportion of the working-age population will reduce the growth rate of GDP per capita. Of course, it is possible to mitigate the headwinds of a declining and aging population by using machines as a substitute for human labor or by promoting innovation. In fact, recent labor shortages in Japan have boosted investment, such as in the automation of production lines and streamlining of operations with the introduction of new information technology. Next, let us consider the impact of a declining and aging population on interest rates. To do so, we need to examine the balance between savings and investment. A declining and aging population would have both positive and negative effects on savings. The negative effect on 1 Japan's total fertility rate in 2016 was 1.44, far below the equilibrium level of about 2.1, under which the population neither increases nor decreases. Meanwhile, France's total fertility rate in 2016 was 1.9. savings is an increase in the number of elderly people. This is because many of them live on running down the assets they had accumulated before retirement, and therefore an increase in their population reduces total national savings and pushes interest rates up. On the other hand, if population aging is accompanied by an increase in longevity, this will positively affect savings. Since World War II, longevity has been increasing in developed countries through advances in medical technology, and we are now likely to live longer than our parents and grandparents. Therefore, even if the proportion of elderly people increases, they may spend less than before or work longer to earn income, both of which will contribute to pushing interest rates down by reducing spending or by increasing savings. How about the impact on investment? A declining and aging population can again either increase or decrease investment, although this also depends on the prospects for the economy and technological progress. A decrease in working-age population and thus in labor input raises the level of capital stock per labor input, and makes capital input relatively abundant.2 This reduces the need for additional investment. Investment is also reduced when firms expect that the population, and therefore the future demand for production, will decline. These are the factors that push interest rates down. Meanwhile, when technological progress or labor-saving investment is prompted to compensate for decreased labor input, this pushes interest rates upward. In this way, a declining and aging population can either push up or push down interest rates. Recent studies suggest that the equilibrium real interest rate in the medium to long run is on a decreasing trend in advanced economies, and a declining and aging population has contributed to this trend to some extent.3 Based on the discussion so far, we can assume that a declining and aging population is likely to increase savings, or decrease investment, or both, at least for the time being. 2 The situation where the level of capital stock per labor input increases is referred to as "capital deepening." 3 Sudo and Takizuka (2018) suggest that about 270 out of the 640 basis points decline in real interest rates over the past 50 years in Japan can be attributed to demographic changes. Sudo, N. and Y. Takizuka "Population Aging and the Real Interest Rate in the Last and Next 50 Years," Bank of Japan Working Paper Series 18-E-1, 2018. II. Impact on Banking Business Since inflation expectations in advanced economies have moved around a small positive value with some variations across countries, a decreasing trend in the equilibrium real interest rate is translated into a decreasing trend in nominal interest rates. Let me now turn to how the demographic changes accompanied by a decreasing trend in nominal interest rates has affected the financial sector. First, I will consider the impact on banking business. In a situation where nominal interest rates on lending are on a decreasing trend, but deposit rates cannot fall below zero, banks' profits are squeezed through a reduction in net interest income. Moreover, if the trend in credit demand weakens due to a declining population and associated weak growth, this puts additional downward pressure on banks' profits in terms of loan volume. In particular, in regions where there is significant decline in population, there will be large downward pressure on credit demand reflecting the rapid decrease in the number of firms and households. If banks' competition intensifies on the back of shrinking demand for credit, this will put further downward pressure on their profits, leading to a reduction in net interest income. Of course, demand for financial services is not necessarily reduced by a decline in population and the number of firms. For example, households are in need of more financial services related to asset management and inheritance on the back of aging and longevity. As the number of elderly households increase, there is greater need for financial services tailored to individual situations such as working conditions, family circumstances, health statuses, and asset holdings. Firms facing a declining population need new business opportunities, technological developments, expanding service territory, and increasing overseas sales. To enable these developments, demands will increase for such financial services as consulting and support for mergers and acquisitions. In addition, the digitalization of financial services has the potential to expand the frontiers of banking business in many ways. On the other hand, if banks are no longer able to keep up with technological innovations and the changing demands of households and firms, a declining population could lead to a reduction in banks' profit opportunities. Banking business requires large fixed costs for the maintenance of branch networks and information technology systems. Therefore, if profit opportunities shrink as the population declines, the over-head ratio (OHR) increases and cost reduction and further consolidation may become necessary to survive. In any case, adaptation to the new environment will proceed gradually across the financial industry as a whole, since population decline and the aging of society occurs over a period of twenty to thirty years. We need to evaluate the impact of demographic changes on the financial system from a variety of perspectives, such as the provision of new financial services, utilization of technological innovation, and progress in consolidation. Regarding financial stability, possible changes in the risk appetite and risk profile of banks, amid a persistent low interest rate environment, is an issue that we central banks are highly attentive to. In the long term, even under a low interest rate environment, securing banks' profitability will depend on whether banks can provide new financial services and expand sources of profits, how technological progress affects the financial industry, and how consolidation of the industry proceeds, including cooperation with non-banking financial or non-financial sectors. In the short term, as downward pressure on banks' profits continues, we need to be mindful of the possible consequences of banks' engagement in excessive risk taking. Generally speaking, risk taking by banks that have abundant capital bases provides financial support to firms' production activities, thereby contributing to economic expansion. Nevertheless, if appropriate risk management measures are not taken and the continued decline in profits leads to insufficient capital bases, credit costs could rise sharply, and the stability of the financial system could be threatened in the event of a large exogenous shock that leads to an economic downturn. The Bank of Japan publishes the Financial System Report semiannually, in which it assesses the stability of financial system and makes various analyses from a macroprudential perspective. In the latest Report published in October, the Bank assessed that Japan's financial system has been maintaining stability on the whole, as financial institutions generally have strong resilience, in terms of both capital and liquidity, during potential tail events such as the Lehman shock. However, regional banks' core profitability has continued to decrease amid both the prolonged low interest rate environment and the persistent decline in the population and the number of firms, and their capital adequacy ratios have also gradually decreased. We should be mindful of the possible consequences, including any downward pressure on the real economy from the financial system, since financial institutions tend to become more cautious in their risk taking if their capital adequacy ratios fall substantially or they continue to register net losses in the event of stress. III. Impact on the Non-Banking Sector Next, let me turn to the non-banking financial sector. Although the activities of the non-banking sector and the associated risks vary across countries and industries, such sector tends to play greater role in financial intermediation in many advanced economies. This comes against the backdrop of a tightening of regulations on the banking sector, a prolonged low interest rate environment, and diversified demand for financial services. For example, in some countries, demand for health and long-term care insurance is expected to increase significantly as the population ages. As the activity of the non-banking sector expands, the risks they carry may also change. We should be particularly mindful of the risks in this sector, posed by the decreasing trend of interest rates amid a declining and aging population. If a low interest rate environment persists, investors tend to become more active in searching for higher yields on assets. This leads non-banking investors to make riskier loans and invest in riskier financial products. If such behavior becomes widespread, they could lead to threatening the stability of the financial system. Amid the increase in demand for insurance and pension products, financial intermediation by asset management companies has expanded in recent years. This basically diversifies the channels of financial intermediation and facilitates efficient allocation of funds. However, it could also lead to complex changes in the risk propagation process under a stressed financial environment and in responses to emergency situations. For instance, asset management companies tend to adopt similar investment strategies. Therefore, their investments may carry the risk of fire sales that could cause asset prices to collapse to levels far below their fundamentals when a negative shock occurs. For the same reason, there is also the risk of drying up of liquidity in the markets. As a result of the financial regulation reforms after the Lehman shock, the banking sector has indeed become more resilient in terms of both capital and liquidity. Nevertheless, there are several issues that still need to be addressed in order to make the global financial system, including the non-banking sector, more resilient. IV. Households' Needs for Financial Services In a low interest rate environment, households also tend to become more active in searching for higher yields on assets, and their engagement in risk taking may affect the financial system in multifaceted ways through diversified financial services. Compared with other countries, households in Japan have a strong tendency to favor safe assets, and even in a prolonged low interest rate environment, a large proportion of household financial assets continue to be deposits. In Japan, however, the elderly hold more stocks than younger people.4 Also, some people seem to begin investing in stocks after retirement. Attention needs to be paid to possible changes in household asset allocation as aging continues. Another important issue in providing financial services to the elderly is the issue of physical weakening and cognitive decline. In general, the elderly are prone to become more vulnerable to financial fraud, and the number of elderly people having difficulty in accessing financial services and making financial decisions is on an increasing trend. All financial institutions, whether in the banking or non-banking sector, as well as the authorities, are facing this challenge and trying to address it. 4 Fujiki et al. (2012) suggest that elderly households in Japan tend to have more stocks than younger households mainly because elderly households have on average more financial assets, while the effects of age per se play a relatively minor role. Fujiki, H., N. Hirakata, and E. Shioji "Aging and Household Stockholdings: Evidence from Japanese Household Survey Data," IMES Discussion Paper No. 2012-E-17, Institute for Monetary and Economic Studies, Bank of Japan, 2012. Concluding Remarks I have talked about the impact of a declining and aging population on the financial sector today. The wave of population aging is already sweeping through many advanced and some emerging market economies. Even in other emerging and developing economies with an increasing young working-age population, they will likely be faced with the problem of aging in the future. It will be increasingly important for financial authorities and financial institutions in many countries to share their knowledge and cooperate in tackling these challenges. Let's take an example of the search-for-yield behaviors mentioned earlier. In countries with low interest rates amid population aging, financial institutions increase loans to and securities investment in emerging economies that offer relatively higher yields. While these kinds of capital flows could mitigate the negative impact of population aging, they may carry new risks to global financial stability. To address these risks, stepping up dialogues among the financial authorities of the countries concerned will be of great benefit. Concerning the financial sector, financial services and business models need to accommodate various changes, including declining and aging population. At the same time, subsequent changes in the risk profiles of financial institutions also need to be considered. The Bank of Japan, while keeping up with these changes, will contribute to ensuring the soundness of financial institutions so that better financial services are provided to firms and households in a stable manner, in cooperation with the various authorities and parties concerned making use of opportunities such as international meetings. Thank you for your attention.
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Speech by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Niigata, 5 December 2018.
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December 5, 2018 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Niigata Masazumi Wakatabe 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 Niigata Prefecture. I also would like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's Niigata Branch. This is my first time to attend a meeting of this kind since I was appointed Deputy Governor of the Bank of Japan in March this year. It is said that people here in the Echigo and Sado regions historically have overcome severe natural environment -- such as dealing with heavy snow, crossing over mountain ridges, and managing floods -- with diligence, patience, and great ingenuity.1 I would like to hear your views on the current status of the local economy, as well as your candid opinions about the Bank's policies and activities. First, I will briefly explain developments in Japan's economic activity and prices, and then talk about the Bank's conduct of monetary policy. I. Current Developments in Economic Activity and Prices Let me start by talking about the current developments in economic activity. Japan's economy is expanding moderately. The real economic growth rate excluding the effects of price movements, after registering relatively high growth of 3.0 percent on an annualized basis in the April-June quarter of this year, marked negative growth of minus 1.2 percent in the July-September quarter. This likely is mainly due to temporary factors accompanying natural disasters that occurred successively this summer. Such a view is underpinned by the fact that exports and production, which had declined due to the effects of natural disasters, have turned to an increase since October. The current economic recovery phase likely has lasted for six years already, which mostly overlaps with the period of quantitative and qualitative monetary easing (QQE) that the Bank introduced in April 2013, and this month its duration is expected to be the same as the Tanaka Keiichi et al., Niigata-ken no rekishi, 2nd ed. (Tokyo: Yamakawa Shuppansha Ltd., 2009), 7. longest post-war recovery phase in the mid-2000s (Chart 1).2 I would like to point out two characteristics of the current prolonged economic recovery, as follows. A. First Characteristic of the Current Recovery: Economic Recovery Being Widespread The first characteristic is that the economic recovery has been widespread, bringing about benefits to a wide range of economic entities. First, in the corporate sector, there has been notable improvement not only in large firms but also small and medium-sized firms (Chart 2). For example, according to our Tankan (Short-Term Economic Survey of Enterprises in Japan), the proportion of small enterprises responding that their business conditions have been "favorable" clearly has exceeded the proportion of those responding that they have been "unfavorable" for the first time since 1991. Corporate profits also have improved widely, with domestic demand increasing under large-scale monetary easing. In particular, profits of small and medium-sized firms that support regional economies clearly have increased. This is a characteristic that was not observed in the economic recovery phase in the mid-2000s, when improvement in corporate profits was uneven, seen mainly in large manufacturing firms that benefited from high growth in overseas economies. Such improvement in the corporate sector -- including small and medium-sized firms in local areas -- has led to firms' more active spending, such as business fixed investment, and its effects also have spread to the household sector through increases in employment and The following studies assess that the Bank's QQE from 2013 has pushed up production and the inflation rate, and also has led to increased employment: (1) Miyao Ryuzo, Hi dentōteki kin'yū seisaku: seisaku tōjisha to shite no shiten [Unconventional Monetary Policies: Perspective of a Policymaker] (Tokyo: Yuhikaku Publishing Co., Ltd., 2016), (2) Ryuzo Miyao and Tatsuyoshi Okimoto, "The Macroeconomic Effects of Japan's Unconventional Monetary Policies," RIETI Discussion Paper Series, no. 17-E-065 (2017), (3) Adachi Seiji and Iida Yasuyuki, eds., Defure to tatakau: kin'yū seisaku no yūkōsei: rejīmu tenkan no jisshō bunseki [Fighting Deflation: The Efficacy of Monetary Policy: Empirical Analysis of Regime Change] (Tokyo: Nikkei Publishing Inc., 2018), and (4) Giovanni Dell'Ariccia, Pau Rabanal, and Damiano Sandri, "Unconventional Monetary Policies in the Euro Area, Japan, and the United Kingdom," Journal of Economic Perspectives, vol. 32, no. 4 (2018): 147-72. wages. The number of job openings has increased significantly, with the active job openings-to-applicants ratio currently standing in the range of 1.6-1.7, a level that exceeds the peak of the bubble period in the late 1980s (Chart 3). Labor market conditions have been tightening across Japan, and the active job openings-to-applicants ratios recently have exceeded 1 in all prefectures, which was not observed even in the bubble period. At the same time, the unemployment rate has declined in a wide range of regions. An improvement in the labor market has been widespread across generations as well. For example, the unemployment rate of the younger generation aged 15-24 rose substantially amid the Japanese financial crisis of the late 1990s, and declined only moderately for a long time after that (Chart 4). However, the situation has changed dramatically in the past few years. The youth unemployment rate has declined to a level below that of the bubble period, and labor market conditions for new graduates have created more of a seller's market than ever before. With the perception of labor shortage heightening further, the number of long-term unemployed workers -- those unemployed for over a year -- has been declining steadily, although it used to be considered quite difficult for them to find a job. In addition, improvement in the employment situation has contributed to providing new job opportunities for those who had not participated in the labor market before. The population aged 15-64 that has played a major role in the labor market, or the so-called working-age population, has been declining from the peak in around 2000. On the other hand, the number of employed persons recently has been increasing substantially (Chart 5). This is a result of labor participation by women and seniors promoted through improvement in employment together with the development of various labor-related measures by the government. In addition, the poverty rate, which has risen moderately since the 1990s, recently seems to have flattened or declined somewhat. The declines in the youth unemployment rate and long-term unemployment rate, as well as the increase in labor participation by women and seniors, are significant not only in terms of increasing the current employment and production but also strengthening the growth potential of the economy in the future. People acquire skills through actually working each day and thereby raise their productivity. In particular, whether or not people have job opportunities to enhance skills in their youth is likely to significantly affect their future careers as well as the productivity of an economy as a whole. Given this, it is very important to provide diverse and stable job opportunities for the younger generation. The decline in the long-term unemployment rate also leads to raising the economy's productivity, since skills could be lost gradually as the duration of unemployment becomes prolonged. Widespread improvement in the labor market is likely to raise the growth potential of Japan's economy. B. Second Characteristic of the Current Recovery: Inflation Rate Turning Positive The second characteristic of the current economic recovery is that wages and prices have turned to an increase under large-scale monetary easing, which is different from the case in the mid-2000s, when prices continued on a declining trend. The year-on-year rate of change in the consumer price index (CPI) has been on an uptrend for more than five years since autumn 2013, and Japan's economy is no longer in deflation, in the sense of a sustained decline in prices (Chart 6). Price developments clearly have improved compared to the period prior to the introduction of QQE, when the economy experienced prolonged deflation. However, while the Bank's price stability target is to achieve the inflation rate of 2 percent, the current rate is at around 1 percent. I will later talk about this point in detail, together with the Bank's monetary policy. II. Outlook for Economic Activity and Prices Now I would like to explain the outlook for economic activity and prices. A. Outlook for Economic Activity I will first touch upon the outlook for economic activity. Japan's economy is expected to continue on an expanding trend from fiscal 2019 through fiscal 2020. Corporate profits at high levels and improvement in the employment situation are expected to bring about increases in business fixed investment and private consumption, with overseas economies continuing to grow firmly on the whole. However, there are various risk factors to this baseline scenario, including developments in overseas economies. In particular, the consequences of the trade friction between the United States and China still warrant some attention. In addition to this friction, various problems exist between the two countries, including those regarding intellectual property rights, technology transfer, and national security. Thus, the situation may remain highly uncertain ahead of resolution of these problems. At this point, the impact of these problems on economic activity at home and abroad is likely to be limited. However, if the problems become more complex and prolonged, downward pressure on the global economy could heighten not only through the gradual spread of the negative effects on trade activity, but also deterioration in firms' fixed investment stance and cautiousness in financial market sentiment. Looking back, the Great Depression of the 1930s is well known as a period when protectionist policies prevailed around the world. Subsequent research suggests that what mainly brought about the significant global economic downturn was severe deflation under fiscal and monetary policies not responding appropriately, rather than protectionist policies.3 Therefore, policy authorities worldwide should bear in mind the importance of fiscal and monetary policy management. Furthermore, attention should be paid to the fact that it is difficult to analyze the effects of protectionist moves on the economy. 4 This is partly because trade structure characterized by the network of global supply chains is far more complex compared to that in the 1930s, the share of trade volume in the global economy has increased, and the amount of global capital flows has become massive. The Bank will thoroughly examine the consequences of recent developments in the trade friction and their potential effects on Japan's economy. B. Outlook for Prices As for the outlook for prices, the year-on-year rate of change in the CPI in Japan is likely to increase gradually with the economy continuing on an expanding trend. The outlook for prices is considered to be determined basically by two factors: the supply-demand balance of the economy as a whole and people's expectations for future price developments. Regarding the supply-demand balance, the tendency of demand exceeding supply is likely For example, see Douglas A. Irwin, Clashing over Commerce: A History of US Trade Policy (Chicago: University of Chicago Press, 2017), 397-400. While traded goods were mainly primary products at the time of the Great Depression, the share of manufactured goods in trade is large at present. As the proportion of manufactured goods increases among traded goods, trade volume tends to fluctuate to a larger degree in response to changes in income. For details, see Douglas A. Irwin, Trade Policy Disaster: Lessons from the 1930s (Cambridge: MIT Press, 2012), 167n25. to continue with the economy following an expanding trend. As actual wages and prices increase along with this development, people's inflation expectations are expected to rise gradually, and thus moderate inflation is more likely to be achieved. There are various risk factors to the outlook for prices as well. For example, we cannot deny the possibility that actual wages and prices will not rise easily despite excess demand continuing going forward. Even when wages and prices rise, there is a possibility that such movements will be perceived as a temporary phenomenon and people's inflation expectations will not rise. Moreover, the scheduled consumption tax hike in October 2019 poses another risk for economic activity and prices.5 Households in Japan tend to respond sensitively to price rises, partly because they have not experienced inflation for a long time. Reflecting such behavior of households, firms have been cautious about raising prices of products. As the economy continues to improve, this cautious stance of firms and households is likely to dissipate gradually, although there is uncertainty as to when this change will occur. Such a situation may be due in part to a lack of public understanding regarding the reasons why economic expansion accompanying moderate inflation is desirable and of public confidence in the Bank's determination to achieve it. If this is the case, the Bank should never be complacent and continue making efforts to communicate better to the public. I would like to talk about this point hereafter, together with the discussion on monetary policy. III. Monetary Policy Let me now move on to monetary policy. The Bank has continued large-scale monetary easing by, for example, maintaining 10-year Japanese government bond (JGB) yields at extremely low levels of around zero percent through purchasing large amounts of JGBs in As shown in the Bank's Comprehensive Assessment released in September 2016, there are three reasons why the inflation rate did not reach the price stability target of 2 percent within two years as initially expected: the decline in crude oil prices, the slowdown in emerging economies, and the consumption tax hike. The Bank estimates that the net burden on households due to the scheduled consumption tax hike in October 2019 will be smaller than that at the time of the tax hike in April 2014. However, it is necessary to carefully examine the effects of the scheduled consumption tax hike on people's consumption behavior and inflation expectations. the market. It also has committed to continuing with such monetary easing going forward. In what follows, I would like to talk about the Bank's basic thinking as to why it is continuing with monetary easing and what it aims to achieve. A. Negative Effects of Deflation Why is the Bank aiming at price stability? Needless to say, households and private firms are the main players in a market economy, but a market economy sometimes may not function well. Therefore, the government and public institutions would need to complement it properly. Price stability is one of the areas in which public institutions should be involved.6 The principle of the Bank's monetary policy is stipulated by the Bank of Japan Act. Article 2 prescribes that "[c]urrency and monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby contributing to the sound development of the national economy." The ultimate objective is not price stability itself but the resultant sound development of the national economy, generally accompanied by improvements in employment and household income. Historically, the economy was negatively affected not only by rapid inflation, such as experienced after World War II and in the 1970s, but also serious deflation around the time of the Showa Depression in the prewar period and deflation that lasted for about 15 years since the late 1990s. Although people tend to think price declines are favorable because goods can be purchased at a cheaper price, they actually give rise to significant negative effects in three respects. First, declines in prices refer not only to those of goods and services that you purchase, but also those of goods and services that your firm sells. If sales of your firm decrease, this reduces your salary and consequently the budget available for spending, or can lead to cutbacks in employment. As a result, economic activity as a whole will contract. In the context of price stability, prices refer to the aggregated prices of goods and services in the economy as a whole, which differ from individual prices of goods and services. In the long run, prices on an aggregate basis are determined by the relationship between the total amount of goods and services transacted in the economy and money. That is, in the long run, prices will rise if money increases, and will decline if it decreases. In modern society, most money is in the form of bank deposits, which are created partly by bank lending, and its base is issued by the central bank. Second, price declines bring about difficulties in conducting economic policies. In an economy where prices decline, tax revenue does not increase easily. Price declines also may be an obstacle to the conduct of monetary policy. When an economy is under downward pressure, it usually becomes necessary to reduce interest rates to support the economy. Theoretically and empirically, however, interest rate levels tend to decrease to around 0 percent when prices decline (Chart 7). Thus, room for monetary policy response becomes smaller if we rely only on the conventional policy of lowering interest rates, which would make economic depression more severe. Third, when economic depression lasts for a long time amid price declines, there is a risk that the growth potential of the economy would be lowered and the behavior and mindset based on the assumption that prices do not rise will become entrenched in the society, as I mentioned earlier. In other economies, nominal GDP and nominal income increase steadily amid moderate inflation. From a global perspective, I have to say that the past situation for Japan's economy was quite exceptional, in that nominal GDP and nominal income peaked out and subsequently leveled off for a long time under prolonged deflation (Chart 8). Price declines may bring about significant negative effects on the economy, even if their pace is moderate or does not accelerate. B. Price Stability Target of 2 Percent On this basis, price stability needed for the sound development of the national economy involves avoiding not only rapid inflation but also deflation. Metaphorically speaking, this is like maintaining a comfortable room temperature. A room's temperature should not be too hot or cold. So, as for prices, should we aim at literally 0 percent inflation? In a situation where the inflation rate is around 0 percent, room for monetary policy response through interest rate control would be limited, as I mentioned earlier. Under such circumstances, there is a risk of economic stagnation and deflation becoming prolonged once downward pressure is exerted on the economy. Thus, one can draw the conclusion that the "appropriate level of temperature for the economy" -- in other words, the inflation rate at which central banks should aim -- is not literally 0 percent but a sufficiently positive figure, which secures room for monetary policy response to avoid deflation.7 In relation to the "appropriate level of temperature for the economy," an increasing number of central banks worldwide have adopted inflation targeting as a framework for monetary policy, and setting the target level at around 2 percent has become a global standard among advanced economies and regions (Chart 9).8 As financial markets and economies are closely linked internationally, aiming at 2 percent inflation when other economies do so has an important implication. For example, while it should be noted that the Bank's monetary policy does not target foreign exchange rates, the fact that Japan aims at achieving the same inflation rate as many other economies, including the United States and Europe, is likely to stabilize foreign exchange rates from a long-term perspective, and thereby contribute to establishing a business environment that enables firms to make decisions easily and continue with their activities without unnecessary anxiety. Based on these considerations, the Bank has set 2 percent inflation as the price stability target and committed to achieving it. This is the Bank's commitment and a declaration to the general public. As long as this is ensured, the experience of the deflationary era will not be repeated. At present, although the inflation rate in Japan is improving steadily, it has remained at around 1 percent, and thus we are only halfway to achieving 2 percent inflation. In a case where downward pressure is exerted on the economy again, it may revert to deflation. The Bank will encourage a rise in the inflation rate to the level that is appropriate for the economy by continuing large-scale monetary easing with the aim of achieving 2 Those who proposed inflation targeting at an early stage considered that the most convincing reason for aiming at a positive inflation rate was avoiding a risk of falling into deflation. For details, see Ben S. Bernanke et al., Inflation Targeting: Lessons from the International Experience (Princeton: Princeton University Press, 1999), 29-30. Although it depends on the definition, approximately 40 central banks now adopt inflation targeting. For details, see José De Gregorio et al., "IMF Reform: The Unfinished Agenda," CEPR (2018): 12. percent inflation and thereby maintaining economic improvement for a sufficiently long period.9 In continuing with monetary easing, it is necessary to continuously examine not only the effectiveness on inflation but also the impact on the financial markets and system. This is expected to enhance the sustainability of the policy and consequently raise the certainty of achieving 2 percent inflation.10 C. Communication to the General Public In order to enhance policy effects, I think that it is important for the Bank to engage in information dissemination and communication so that as many people as possible would understand the state of the economy that the Bank aims to achieve, as well as its underlying thinking. The conventional monetary policy that we learned at school mainly focuses on raising or lowering interest rates, which was relatively easy to understand. However, in Japan since the late 1990s and in the United States and Europe since the Global Financial Crisis in the late 2000s, short-term interest rates have been close to 0 percent, which is an environment that cannot be dealt with only through conventional monetary policy. Under these circumstances, central banks actively adopted the so-called unconventional monetary policy. This produced extremely powerful effects during the course of the global economy moving out of the Global Financial Crisis. At the same time, however, monetary policy became highly complex and difficult to understand for some non-experts. Outside Japan, There are various debates over why the target level of inflation should be 2 percent, or what would be the most desirable inflation rate. Recent studies increasingly suggest that the desirable inflation rate be positive in view of preventing a risk of falling into deflation, based on the experience of the Global Financial Crisis from 2008. However, the proposed specific figure ranges widely from a positive rate close to 0 percent to around 6 percent. Meanwhile, Seiji Adachi argues that, using the data for Japan's economy from 1983 through the second quarter of 2017, the inflation rate that would be achieved under certain conditions in a time of an inflationary regime is 1.94 percent in terms of the CPI inflation rate excluding fresh food and energy. For details, see Adachi Seiji, "2 pāsento no infure mokuhyō wa datō ka," Keiki to Saikuru, no. 64 (2017): 3-16. The Bank has been making a wide variety of efforts including conducting on-site examinations and off-site monitoring of individual financial institutions, providing a wide range of information such as through the Financial System Report, and cooperating with relevant regulatory authorities in the development of financial regulations. some appear to have joked that central banks' public statements can only be understood by those with a Ph.D. in economics. It is true that the Bank's current policy is somewhat technical, and we are expected to communicate in detail to gain understanding from experts including market participants and overseas authorities. Nevertheless, it is important for central banks to reach out not only to experts but also households and firms, which play the main roles of and are driving forces for Japan's economy.11 Regarding households and firms, I am aware that it is important to reiterate the essence of the policy -- that is, what the Bank aims at and how it seeks to achieve this -- rather than the details that tend to be highly technical. For example, according to a survey conducted by the Bank, many households think that their circumstances become worse off when prices rise (Chart 10). No one welcomes price rises when their own income does not increase. Thus, it may seem natural that households' tolerance of price rises would not increase easily, but wages generally grew at a higher pace than inflation and households' purchasing power rose in the past phase of moderate inflation (Chart 11). In order to change the cautious stance of households that tend to be reluctant to accept price rises, it also is important to explain this basic mechanism of the economy in a way that is easy to understand. In addition, the effects of monetary policy depend on economic conditions. The expected growth rate of Japan's economy is likely to rise as private firms actively undertake investment in capital and human resources as well as innovation, or as the government establishes a business environment that encourages such investment for the future or makes beneficial public spending, including that for education as well as for the promotion of science and technology, while securing confidence in fiscal sustainability. As the expected growth rate rises, monetary easing will more significantly boost the willingness of firms to invest and households to consume, thereby further ensuring the path toward achieving the price stability target of 2 percent. Thus, there are synergy effects between efforts by various economic entities and the Bank's monetary policy. With a view to sharing among various entities the significance of these effects, the For a study that underlines the importance of influencing households' and firms' expectations, see, for example, Olivier Coibion et al., "Inflation Expectations as a Policy Tool?" NBER Working Paper, no. 24788 (2018). Bank needs to communicate effectively to a wide range of people. I suppose that those attending this meeting also experience situations where it is necessary to convey a message to residents and clients in plain language while engaging in complex day-to-day operations. The same applies to monetary policy. Taking account of this, I have explained today the essence of the Bank's thinking behind monetary policy. Conclusion Lastly, I would like to talk about the economy of Niigata Prefecture. The economy has continued to recover steadily. Exports and production have maintained their relatively high levels, mainly on the back of favorable external demand. Amid high levels of corporate profits, business fixed investment intended for enhancing capacity and saving labor has increased. With labor market conditions tightening, employee income has increased moderately and private consumption also has recovered moderately. On the other hand, Niigata Prefecture is facing challenges such as population decline, labor shortage, and sluggish final demand. However, the prefecture's economy has some advantages in overcoming these challenges and thereby achieving economic growth. For instance, there is an agglomeration of industries with high technological prowess in a wide range of fields such as metals, machinery, food, materials, and construction. In addition, the information and communications industry has started to make advancements, as partly evidenced by launches of new IT firms. As traditionally strong industries adjust to globalization and technological progress, and new industries such as the information and communications industry start up, the growth potential of the prefecture's economy is expected to heighten further. Moreover, Niigata Prefecture is blessed with a varied culture and history, as well as abundant nature and food. This summer, I enjoyed an exhibition at the Tokyo National Museum entitled "JOMON: 10,000 Years of Prehistoric Art in Japan." I was overwhelmed by the sublime beauty of the national treasure from Niigata Prefecture -- a vessel with flame-like ornamentation from the Sasayama site in Tōkamachi city. The prefecture is also famous for its sake (rice wine), and this owes to the entrepreneurial spirit that sought to diversify product lines and enhance their quality against the background of declining prices of rice in the Edo era that resulted from excess supply. 12 Furthermore, while Koshihikari is now a byword for delicious rice, efforts were needed to overcome many difficulties to get to that point.13 Another significant advantage is that the prefecture is close to the growing economies of northeast Asia. It has close historical relations with regions on the opposite shores, such as the Russian Far East, China, and the Korean Peninsula. With the traditions of trade via Kitamaebune, or northern-bound ships, Niigata Prefecture now has the potential as the largest foothold for international interaction along the Sea of Japan to capture demand from fast-growing Asian economies, both in terms of trade and tourism. January 2019 marks the 150th anniversary since the Niigata port was opened to the world as a trade port ahead of many other ones. As I mentioned at the outset, people here in the Echigo and Sado regions historically have overcome challenges with their diligence, patience, and ingenuity. I would like to close by expressing my hope that you will be frontrunners in terms of overcoming deflation and vitalizing local economies while making the most of the prefecture's advantages. Thank you very much for your attention. According to a history book, sake breweries in Niigata Prefecture in the Edo era tried to grasp the taste of consumers by inviting specialists based long distances away. Specifically, Buzaemon from the Uonuma Shiozawa region, who started a sake brewery in the late 1600s, and Kaemon from the same region invited tōji -- sake brewers -- from Kyoto and Tokyo, respectively. For details, see Tanaka Keiichi et al., Niigata-ken no rekishi, 2nd ed. (Tokyo: Yamakawa Shuppansha Ltd., 2009), 166-67. Koshihikari originally was developed at an agricultural experiment station in Niigata Prefecture during wartime in 1944, when quantity generally was prioritized over taste, and its breeding business subsequently was suspended. After the launch of the Koshihikari brand, the Agricultural Cooperative Association of Niigata Prefecture spared no marketing efforts to enhance its brand value ahead of the competitors. For details, see Sakai Yoshiaki, Koshihikari monogatari: nippon-ichi umai kome no tanjō (Tokyo: Chuokoron-Shinsha, Inc., 1997). Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Niigata December 5, 2018 Masazumi Wakatabe Deputy Governor of the Bank of Japan Chart 1 Japan's Economy Index of Business Conditions CY 2010=100 Length of Economic Recovery Period Rank Period Length February 2002February 2008 73 months December 2012- November 1965July 1970 (Izanagi Boom ) 57 months December 1986February 1991 (Bubble Boom ) 51 months November 1993May 1997 43 months CY 85 Notes: 1. The left chart shows the coincident index. Shaded areas indicate recession periods. Notes: 2. Business cycle peaks and troughs are determined in light of discussions by experts after economic data accumulation. Sources: Cabinet Office, etc. 70 months (as of September 2018) Chart 2 Widespread Economic Recovery I: Corporate Sector – Improvement of Small Enterprises – Business Conditions by Enterprise Size (Tankan) DI ("favorable" - "unfavorable"), % points Scale of Improvement in Corporate Profits tril. yen Large enterprises "Favorable" Small enterprises "Unfavorable" Small enterprises, etc. Large enterprises (nonmanufacturing) -20 -40 Large enterprises (manufacturing) -60 CY 85 FY 2001→2007 FY 2012→2017 Notes: 1. Figures in the left chart are based on Tankan. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Notes: 2. Figures in the right chart are based on current profits of the Financial Statements Statistics of Corporations by Industry, Quarterly. "Large enterprises" are enterprises with capital of 1 billion yen or more and "small enterprises, etc." are the rest. Excluding "finance and insurance." Sources: Ministry of Finance; Bank of Japan. Chart 3 Widespread Economic Recovery II: Labor Market Active Job Openings-to-Applicants Ratio (by Prefecture) 3.0 s.a., ratio Range of active job openings-toapplicants ratios of all prefectures 2.5 Nationwide Unemployment Rate (by Prefecture) s.a., % Range of unemployment rates of all prefectures Nationwide 2.0 1.5 1.0 0.5 0.0 CY 85 CY 97 Note: Seasonally adjusted figures for unemployment rates of all prefectures are based on BOJ staff estimations. Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 4 Widespread Economic Recovery III: Labor Market Youth Unemployment Rate Unemployment Rate (Long- and Short-Term) s.a., % 4.5 Unemployment rate (total) Unemployment rate (aged 15-24) % Short-term unemployment rate Long-term unemployment rate 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 CY 85 0.0 CY 85 Note: In the right chart, long- and short-term unemployment rates are the ratios to labor force of those who have been unemployed for one year or over and less than one year, respectively. Figures for 2018 are January-September averages. Source: Ministry of Internal Affairs and Communications. Chart 5 Widespread Economic Recovery IV: Labor Market Population Aged 15-64 and Number of Employed Persons mil. persons Number of Employed Persons cumulative change from the beginning of CY 2000, mil. persons Aged 65 or over Female aged 15-64 Male aged 15-64 Total CY 75 -2 Unemployed persons Employed persons Population aged 15-64 Source: Ministry of Internal Affairs and Communications. -4 CY 00 Chart 6 Developments in Prices Consumer Prices y/y % chg. CPI (all items less fresh food) CPI (all items less fresh food and energy) Average from FY 2013 onward +0.5% -1 Average from FY 1998 to 2012 (all items less fresh food and energy) -0.4% -2 -3 CY 85 Note: The CPI figures are adjusted for changes in the consumption tax rate. Figures for 2018/Q4 are those for October. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 7 Inflation Rates and Interest Rate Levels Australia United Kingdom Overnight interest rate (%) Canada United States Euro area Japan Switzerland -1 -1 Inflation rate (%) Note: Figures for the inflation rate and the overnight interest rate are averages from 2000 to 2017. Source: OECD. Chart 8 Economic Growth of Major Economies Nominal GDP Growth Real GDP Growth CY 1991=100 CY 1991=100 United States United Kingdom France Germany Japan CY 1991 CY1991 Source: IMF. Chart 9 Price Stability Target Number of Countries Adopting Inflation Targeting Price Stability in Advanced Economies countries Country/ Region Definition United States (FRB) Longer-run goal Euro area (ECB) Quantitative definition United Kingdom (BOE) Target Japan (BOJ) Price stability target (y/y chg.) CY 1990 Indicator Numerical expression Note: PCE is personal consumption expenditures; HICP and CPI are consumer price indexes. Sources: Gregorio, Eichengreen, Ito, and Wyplosz (2018); Bank of Japan; Federal Reserve Board; European Central Bank; Bank of England. PCE deflator 2% HICP Below, but close to, 2% CPI 2% CPI 2% Chart 10 Households' Views Comments on the Price Rise "Rather favorable" (4.6%) "Difficult to say" (16.2%) "Rather unfavorable" (78.4%) Comments on the Price Decline "Rather unfavorable" (26.7%) "Difficult to say" (20.0%) "Rather favorable" (43.3%) Recognition of the Price Stability Target of 2 Percent "Know about it" (30.6%) "Have read or heard of it, but do not know much about it" (37.5%) "Have never heard of it" (31.4%) Source: Bank of Japan, Opinion Survey on the General Public's Views and Behavior (September 2018 survey). Chart 11 Prices and Wages Japan United States average of y/y % chg. average of y/y % chg. Consumer prices Consumer prices Nominal wages (hourly earnings) -2 Nominal wages (hourly earnings) -2 1980s 1990s 2000s 2010s 1980s 1990s 2000s Note: Figures for the 2010s are averages from 2010 to 2017. Consumer prices are CPI (all items, adjusted for changes in the consumption tax rate) for Japan, and PCE deflator (all items) for the United States. Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bank of Japan; Haver. 2010s
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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, 6 December 2018.
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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, 6 December 2018. * * * Introduction The Bank of Japan submits to the Diet its Semiannual Report on Currency and Monetary Control every 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 I will first explain economic and financial developments in Japan. Japan’s economy is expanding moderately, with a virtuous cycle from income to spending operating. Although the real GDP growth rate for the July-September quarter was slightly negative, this is likely to be mainly due to the effects of temporary factors such as natural disasters. Looking at this in more detail, exports have been on an increasing trend amid overseas economies continuing to grow firmly on the whole. Business fixed investment has continued on an increasing trend, with corporate profits following their improving trend and business sentiment staying at a favorable level. Private consumption has been increasing moderately, albeit with fluctuations, against the background of steady improvement in the employment and income situation. Going forward, Japan’s economy is likely to continue its moderate expansion. Risks to the outlook are skewed to the downside, particularly regarding developments in overseas economies, including the consequences of protectionist moves and their effects. On the price front, the year-on-year rate of change in the consumer price index (CPI) has been positive but has continued to show relatively weak developments compared to the economic expansion and the labor market tightening. This is largely attributable to the fact that firms’ cautious wage- and price-setting stance as well as households’ cautiousness toward price rises have been deeply entrenched, due mainly to the experience of prolonged low growth and deflation. In addition, such factors as the large room to raise productivity, mainly in the nonmanufacturing sector, and the technological progress in recent years have allowed firms to maintain their cautious stance toward raising prices, even amid the economic expansion. With regard to the outlook, however, the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent, mainly on the back of the output gap remaining positive and mediumto long-term inflation expectations rising. The momentum toward achieving the price stability target of 2 percent is maintained but is not yet sufficiently firm, and thus developments in prices continue to warrant careful attention. II. Conduct of Monetary Policy Next, I will explain the Bank’s conduct of monetary policy. The Bank has been conducting powerful monetary easing under the framework of “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control” introduced in September 2016. In terms of yield curve control, with a view to facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target of 2 percent, the Bank has conducted purchases of Japanese government bonds (JGBs) under the guideline for market 1/2 BIS central bankers' speeches operations, in which it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent. At the July Monetary Policy Meeting (MPM), with a view to persistently continuing with such powerful monetary easing, the Bank decided to strengthen the current policy framework. First, the Bank introduced forward guidance for policy rates, with which it intended to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time. This aims to clarify the policy stance of continuing with powerful monetary easing by making clear future policy rates in advance. Second, the Bank decided to conduct market operations and asset purchases in a more flexible manner. As the degree of market functioning consequently improves, such as through interest rate formation becoming more flexible, this likely will lead to enhancing the sustainability of the policy. The Bank deems that such policy responses will lead to achieving 2 percent inflation at the earliest possible time while securing stability in economic and financial conditions. It will continue to examine the risks considered most relevant to the conduct of monetary policy and conduct its policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. Thank you. 2/2 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 meeting with business leaders, Fukuoka, 29 November 2018.
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November 29, 2018 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Fukuoka Takako Masai Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices I would like to start my speech with a look at developments in economic activity and prices. Following the discussion at the Monetary Policy Meeting (MPM) held on October 30 and 31, 2018, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices through fiscal 2020. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas Economies Let me first touch on developments in overseas economies. The Bank's assessment is that overseas economies have continued to grow firmly on the whole. Looking at recent developments in overseas economies, their growth is losing momentum compared to a while ago, when the global economy was widely referred to as seeing synchronous growth. A virtuous cycle of overseas economic activity has been maintained, however, as seen in the fact that domestic demand in many economies has been firm. According to the World Economic Outlook (WEO) released in October 2018 by the International Monetary Fund (IMF), the real GDP growth rate of the global economy is projected to be 3.7 percent on a year-on-year basis for both 2018 and 2019. The projections have been revised downward by 0.2 percentage point for each year from the previous ones released three months before, and differences in growth rates among regions have widened to some extent. Nonetheless, the growth rate of 3.7 percent is by no means low, as this figure represents a level exceeding its past average. Let me outline the Bank's outlook for overseas economies by major region. The U.S. economy is expected to maintain its expansion, underpinned by expansionary fiscal measures. The European economy is projected to continue recovering, albeit at a gradually slowing pace. The Chinese economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policy in a timely manner, although it is expected to be affected to some extent by the United States having raised tariffs imposed on China. B. Japan's Economy 1. Current situation Now I would like to move on to developments in Japan's economy. The Bank's assessment is that Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating. The output gap -- which shows the utilization of capital and labor -- widened within positive territory from late 2016, for seven consecutive quarters through the April-June quarter of 2018. Although the first preliminary estimate of the real GDP growth rate for the July-September quarter -- released on November 14 -- was minus 1.2 percent on an annualized quarter-on-quarter basis, this is considered to be largely attributable to the temporary effects of natural disasters that occurred successively this summer. In fact, exports and production decreased slightly following these disasters, but have been showing recovery thereafter. Corporate profits have continued to follow their uptrend at record high levels, and business fixed investment also has continued on an increasing trend. According to the September 2018 Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment plans for fiscal 2018 registered a year-on-year increase of 8.7 percent -- a level clearly exceeding the past average for the September Tankan surveys. Meanwhile, labor market conditions have continued to tighten steadily and total cash earnings per employee have risen moderately. Under these circumstances, the consumption activity index (CAI) -- which is calculated by combining various sales and supply-side statistics -- increased for the April-June quarter on a quarter-on-quarter basis and continued to do so for the July-September quarter relative to the previous quarter. 2. Outlook I will now look at the outlook for Japan's economy during the projection period, which covers from fiscal 2018 through fiscal 2020. The economy is likely to continue its moderate expansion. In fiscal 2018, Japan's economy is likely to continue growing at a pace above its potential growth rate, which is estimated to be in the range of 0.5-1.0 percent, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending, with overseas economies continuing to grow firmly on the whole. From fiscal 2019 through fiscal 2020, the economy is expected to continue on an expanding trend, partly supported by external demand, although the growth pace is projected to decelerate due to a cyclical slowdown in business fixed investment and the effects of the scheduled consumption tax hike in October 2019. In terms of the median of the Policy Board members' forecasts in the October 2018 Outlook Report, the real GDP growth rate is 1.4 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020. I also hold the view that the Bank's baseline scenario has been maintained, in which Japan's economy is likely to continue its moderate expansion. As the reason for this, I would like to highlight two positive factors for the economic outlook. The first is the strength in business fixed investment, which I mentioned earlier. In addition to the high growth in the investment amount itself, I am reassured by the fact that firms in a wide range of industries have been planning a variety of investments, such as (1) that intended for domestic capacity expansion, (2) that in research and development, (3) that aiming at improving efficiency and saving labor, and (4) that aiming at enhancing business continuity arrangements in preparation for times of disaster or other emergency. The second positive factor is that, fortunately, the effects of this summer's natural disasters on Japan's economic activity are likely to be only temporary. According to information we obtained from, for example, interviews with firms conducted by the Bank's branches, many of the firms for which production and distribution were undermined already have accelerated their production to offset the impact of the disasters. Moreover, public investment toward restoration and rebuilding is projected to take hold going forward. Although the extent to which the disasters affect inbound demand was a matter of concern at first, such demand has been showing faster recovery than expected, partly reflecting successful results of the government's and the private sector's provision of relevant information to the public. I believe that efforts that take advantage of lessons learned in the past have been playing a role in post-disaster restoration and rebuilding this time as well. 3. Uncertainties regarding economic activity Meanwhile, there are various uncertainties regarding the baseline scenario of the outlook for Japan's economic activity. On this point, risks recently appear to be tilted to the downside, particularly regarding developments in overseas economies. Specifically, risks to overseas economic developments include the following: the U.S. macroeconomic policies and their impact on global financial markets; the consequences of protectionist moves and their effects; developments in emerging and commodity-exporting economies including the effects of the two aforementioned factors; negotiations on the United Kingdom's exit from the European Union (EU) and their effects; the fiscal problem in Italy; and geopolitical risks. Of these risks, I remain especially concerned about protectionist moves; in particular, the trade friction between the United States and China. In fact, the deterioration in Chinese firms' sentiment toward business conditions, particularly those related to exports and imports, has been distinct. Although no significant changes have been evidenced, for example, by Chinese statistics on exports and imports, some have pointed out the possibility that China's trade activity has been buoyed temporarily by the front-loading of exports to the United States prior to a looming rise in tariffs. Thus far, the effects of the U.S.-China trade friction on Japan's economy have been limited. There is an argument, however, that if it takes time to ease this tension, this may result in a direct negative impact on Japan's economy through trade activity, and may adversely affect the economy to a greater extent through such channels as the deterioration in business sentiment and the destabilization of global financial markets. The IMF and other international organizations have released similar results in their simulation analyses on the effects of the U.S.-China trade friction on the global economy. According to these analyses, the extent to which this trade friction directly impacts the economy through trade activity is likely to be limited, but the effects of this issue would be larger when involving such channels as the deterioration in business sentiment and the destabilization of global financial markets. I believe that we should not be inclined toward extremely pessimistic views in this regard, mainly because an agreement has been reached in the renegotiation of the North American Free Trade Agreement (NAFTA) and there has been ongoing dialogue between the United States and China toward easing the tension. However, I will continue to closely monitor the effects of protectionist moves on economic activity overseas and in Japan. C. Price Developments Next, I will turn to price developments in Japan. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food slowed temporarily in early spring 2018, but it has been accelerating again since summer, having risen to around 1 percent recently. Nevertheless, the year-on-year rate of change in the CPI excluding energy in addition to fresh food has been at around 0.5 percent of late, and the underlying trend in prices in Japan has continued to show relatively weak developments compared to the economic expansion and the labor market tightening. This is likely to be attributable to two main factors. The first is the deeply entrenched mindset and behavior based on the assumption that wages and prices will not increase easily. For this reason, firms' wage- and price-setting stance, as well as households' views toward price rises, have remained cautious, and there has not yet been a clear change in this situation. Behind such entrenched mindset and behavior lie Japan's fairly recent 15-year experience of low growth and a mild but persistent decline in prices. In this sense, this first factor can be regarded as people's price perception inherent in Japan, or a kind of social norm in the country. The second factor behind the relatively weak price developments is changes on the supply side of the economy, including active labor-saving investment and intensifying competition among firms, which have been brought about by the progress in digital technology, as well as an increase in labor participation by women and seniors. For example, it has been pointed out that retailers such as supermarkets maintaining their cautious price-setting stance is partly due to the expansion of online shopping. Unlike the first factor, such intensifying competition brought about by technological progress can be described as a structural change observed globally, rather than only in Japan. As I have explained, Japan has continued to see a situation where the underlying trend in inflation does not rise easily. Nonetheless, with the output gap remaining positive and operating firmly as a driver for a rise in inflation, the year-on-year rate of change in the CPI is likely to increase gradually toward the price stability target of 2 percent. In terms of the median of the Policy Board members' forecasts in the October 2018 Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is 0.9 percent for fiscal 2018 and -- on a basis excluding the effects of the scheduled consumption tax hike -- 1.4 percent and 1.5 percent for fiscal 2019 and 2020, respectively. II. The Bank's Monetary Policy A. The Basic Thinking behind the Bank's Policy 1. Continuing powerful monetary easing Thus far, I have talked about Japan's economic activity and prices. Next, I will explain the Bank's monetary policy. In order to overcome prolonged deflation, the Bank introduced in April 2013 an unprecedented and highly accommodative monetary policy, quantitative and qualitative monetary easing (QQE). Since then, the Bank has supported firms' and households' economic activity by maintaining highly accommodative financial conditions and contributed to an improvement in the output gap. At present, Japan's economy has improved significantly, and in terms of prices, it is no longer in deflation, in the sense of a sustained decline in prices. As I touched on earlier, the underlying trend in prices in Japan has continued to show relatively weak developments compared to the economic expansion. Nevertheless, the mechanism whereby an improvement in the output gap leads to a rise in inflation has continued to operate and the momentum toward 2 percent inflation has not been lost. Therefore, I consider it appropriate to persistently maintain the current highly accommodative financial conditions so as to keep the output gap within positive territory for as long as possible, thereby sustaining the positive momentum I just mentioned. Specifically, I believe that it is necessary that the Bank persistently continue with powerful monetary easing under the framework of QQE with Yield Curve Control, introduced in September 2016. This framework consists of two components: yield curve control and an inflation-overshooting commitment. Yield curve control is a policy under which the Bank aims to keep short- and long-term interest rates stably at low levels. Namely, 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 10-year Japanese government bond (JGB) yields at around 0 percent, and conducts JGB purchases so as to achieve this target level. The inflation-overshooting commitment is a policy under which the Bank commits itself to continuing to expand the monetary base -- the total amount of money the Bank directly supplies to the economy -- until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. Through this commitment, the Bank aims at increasing people's confidence in the achievement of the 2 percent price stability target. 2. Policy effects and side effects While monetary easing stimulates the economy, keeping interest rates low across the entire yield curve for a prolonged period could exert adverse effects on the functioning of the JGB market and profits of financial institutions. Therefore, the Bank deems it necessary to proceed with policy conduct while examining policy effects and the possible side effects from every angle, as well as carefully assessing their costs and benefits to the economy. Based on this thinking, the Bank has pursued strong monetary easing by taking into account the situation at the time. Moreover, at the MPM held on July 30 and 31, 2018, it decided to further strengthen the framework of QQE with Yield Curve Control: the Bank introduced forward guidance for policy rates and decided to conduct market operations as well as asset purchases in a more flexible manner. As for the long-term interest rate, for example, the Bank made clear that, while it would maintain the target level of "around zero percent," the observed yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. As for exchange-traded fund (ETF) purchases, it was announced that the Bank might increase or decrease the amount of purchases depending on market conditions, while maintaining the annual target of increase at about 6 trillion yen. I believe that conducting these flexible measures will lead to maintaining market functioning. The Bank intends to continue paying careful attention to the risks considered most relevant to the conduct of monetary policy. With a view to achieving the price stability target, it will conduct monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. B. Addressing Changes in the Economic Structure So far, I have explained the Bank's monetary policy measures. In what follows, I would like to talk about the points I keep in mind regarding the basic thinking behind monetary policy. At each MPM, the Bank discusses the current situation of and outlook for developments in economic activity and prices as well as financial conditions, and decides on the conduct of monetary policy that is considered most appropriate for achieving the price stability target. In such policy conduct, I consider it important to make a comprehensive assessment, giving due consideration to various changes in the environment surrounding Japan's economy, such as digital innovation. Digital innovation in recent years has dramatically increased the quality and quantity of information people can obtain in their daily lives. Although it has been only about a decade since smartphones became prevalent among the public, they have disseminated explosively worldwide. In Japan, more than 60 percent of Japanese people own them today. Men and women of all ages carry in their pockets devices that are equivalent to the supercomputers of the past, and can access worldwide information instantly. People's lifestyles are changing significantly with smartphones: they enjoy listening to music and watching videos through digital distribution; do shopping and make travel reservations; look up information more quickly using their devices' search function; and spend leisure time communicating with friends through social media and other digital tools. And it seems that such changes are becoming more rapid. Besides lifestyles, structural changes have been taking place in various aspects. In this regard, let me mention the Federal Reserve Bank of Kansas City's Jackson Hole Economic Policy Symposium held annually in August -- which may not be well known among the public but draws significant attention of central bankers, academics, and economists. At this year's symposium entitled "Changing Market Structure and Implications for Monetary Policy," prominent academics presented interesting papers on the theme of recent shifts in the market structure.1 The topics included increasing differences between firms, the rising importance of intangible assets, and intensifying competition in the banking industry. Of these, I would like to touch on the paper on intangibles.2 This posits that, in recent years, intangible assets -- including software, intellectual property, and brand -- account for an increasingly large share of total capital compared to traditional physical assets such as equipment. The paper then points out that, in the existing data, which do not sufficiently cover the increase in intangible assets, the amount of investment appears to be smaller than the theoretically optimal level. I will not go into more detail, but the paper also refers to the possibility that such an increase in intangible assets may weaken the effectiveness of monetary policy. A similar point of view has been presented from the business sector. Mr. Bill Gates, a well-known co-founder of Microsoft Corporation, claims that, given the ever-increasing importance of software and data in economic activity, policy authorities in each country should debate more actively the important question of the best way to stimulate economic activity.3 These papers are available at the following: https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2018. Nicolas Crouzet and Janice Eberly, "Understanding Weak Capital Investment: the Role of Market Concentration and Intangibles," paper prepared for the Jackson Hole Economic Policy Symposium, August 2018. See https://www.gatesnotes.com/Books/Capitalism-Without-Capital. I think that it is by no means a coincidence that the same issue was raised within academia and the business sector around the same time. This is probably evidence of how significant these changes are and that they are rapidly occurring worldwide. Intangible assets literally are difficult to measure. However, taking just one example -- namely, the importance of these assets being discussed both within academia and the business sector -- reveals that it is becoming hard to assess firms' investment activities and the effects of monetary policy without considering the impact of these assets. Therefore, I believe that it is necessary to adequately address these changes in the economic structure. The actual economy that central banks face is very complex and changing dynamically. It is of course very important to learn economic theories in textbooks and analyze past experiences. However, when authorities and economic entities make decisions, it is my view that they should pay due attention to various factors, such as these structural changes that may not necessarily be evident from economic models, and continue to examine what needs to be done at the time.
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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 2018.
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December 26, 2018 Bank of Japan Japan's Economic and Price Developments and Future Prospects 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. This is the sixth time I have the occasion to give a speech here wrapping up the year. Today, I would first like to talk about the Bank of Japan's view on domestic economic and price developments while looking back on the past six years. Next, I will elaborate on efforts that firms have made so far toward improving productivity, mainly in response to labor shortage, and will then outline future prospects. Lastly, I will explain the Bank's conduct of monetary policy. I. Japan's Economic and Price Developments Economic and Price Developments over the Past Six Years Let me start by looking back at developments in Japan's economy. The economy has improved significantly over the past six years or so since 2013 (Chart 1). The current economic recovery phase, which began in December 2012, is likely to have reached 71 consecutive months this October. If this recovery continues, this month it will match the 73 months of the longest post-war recovery on record. Furthermore, looking at the output gap, which shows the utilization of capital and labor, demand clearly started to exceed supply in late 2016 and the output gap has continued to widen steadily within positive territory for about two years since then. In addition to this long duration, a significant feature of the current economic recovery phase is that the economic expansion is well-balanced in that it is not led only by a specific sector. Looking at business sentiment by industry in the previous prolonged recovery phase in the mid-2000s, improvement in the economy as a whole was driven by certain parts of the manufacturing sector -- such as automobiles and production machinery -- against the background of favorable developments in exports (Chart 2). On the other hand, business sentiment in sectors such as construction and retailing did not improve clearly throughout the recovery phase. Thus, the degree of improvement in business sentiment differed substantially across industries. In contrast, in the current recovery phase, business sentiment has improved evenly across almost all industries in both the manufacturing and the nonmanufacturing sector. The well-balanced nature of the recovery is also confirmed by developments in business conditions by firm size (Chart 3). In the past few years, business sentiment has clearly improved not only among large firms but also small and medium-sized firms. This contrasts with the situation in the previous recovery phase, when the degree of improvement differed significantly between the two. In terms of developments by region, too, the current economic recovery does not center only on major metropolitan areas. The active job openings-to-applicants ratios in local areas have substantially exceeded the levels seen during the bubble period and show improvements comparable to those in major metropolitan areas. One of the reasons for this well-balanced economic recovery is the growth in demand in a wide range of fields. For example, looking at developments in external demand, the previous recovery phase was characterized by notable growth in exports of goods (Chart 4). On the other hand, in the current recovery phase, exports not only of goods but also of services have increased, led by demand from inbound tourism as well as royalties and license fees from the overseas operations of Japanese firms, while growth in external demand as a whole has been moderate. Specifically, the increase in demand from inbound tourism has provided new business opportunities for a wide range of firms, regardless of their region or size. In addition, looking at a breakdown of fixed capital formation in the previous recovery phase, machinery investment increased against the background of growth in exports, while investment in structures such as buildings decreased significantly (Chart 5). In the current recovery phase, investment in both machinery and structures has been increasing. Of these two, the increase in investment in structures is largely attributable to the diversification in investment demand as a result of (1) increases in housing and public investment, (2) investment in office buildings accompanying urban redevelopment projects, (3) the construction of large distribution centers in response to the rapid growth in online shopping, and (4) growing demand for the construction of accommodation facilities to meet demand from inbound tourism. Let me now talk about price developments in Japan over the past six years. The year-on-year rate of change in the consumer price index (CPI) excluding fresh food turned positive in mid-2013 and temporarily rose to 1.5 percent in spring 2014. However, it then flattened and subsequently turned negative, mainly due to the significant decline in crude oil prices (Chart 6). Yet, from around late 2016, the CPI started to increase moderately again in line with the output gap turning positive, and recently has been around 1 percent. The year-on-year rate of change in the CPI excluding fresh food and energy, which more clearly shows the underlying trend in prices, has generally continued to be positive for more than five years since mid-2013. Although the CPI has continued to show relatively weak developments compared to the economic expansion and the labor market tightening, the economy at least no longer has been in deflation over the past few years in the sense of a sustained decline in prices. Recent Economic Developments and Risks concerning Overseas Economies As I just outlined, Japan's economic activity and prices have improved significantly over the past six years. Currently, the economy is continuing its moderate expansion. Although the real GDP growth rate for the July-September quarter of 2018 was negative on a quarter-on-quarter basis, this likely is mainly because of the series of natural disasters, which temporarily have exerted downward pressure on such components as exports, production, and tourism. In fact, looking at developments since October, these components have started to increase again after the decline in the July-September quarter (Chart 7). As for the outlook, Japan's economy is likely to continue its moderate expansion. Regarding this outlook, however, it is necessary to bear in mind that uncertainties have recently been growing, mainly with respect to developments in overseas economies. In particular, it is necessary to pay close attention to recent protectionist moves, including the trade friction between the United States and China. While the results of the recent Tankan (Short-Term Economic Survey of Enterprises in Japan) show that the impact of this problem on Japan's economy so far likely has been limited, some firms have voiced that it is difficult to accurately gauge the potential impact at this point given that economies have become increasingly interdependent through global supply chains. Protectionist policies clearly do not benefit any economy, and it is likely that a brake will be put on excessive protectionist moves at some point. However, if we regard this problem of trade friction as part of the broader issue of determining the future relationship between the United States and China, it is undeniable that resolving the trade friction may take time. In this case, there is also a risk that the impact of this problem on trade activities and economic activities in various economies could become complex and broad-based, and that, depending on future developments, the negative impact could be amplified through a deterioration in business sentiment and instability in financial markets. Attention also needs to be paid to other risks originating from overseas economies such as the possibility that the United Kingdom could end up with a no-deal Brexit, the possibility that policy rate hikes in the United States could lead to capital outflows from emerging economies, and various geopolitical risks including those in the Middle East. Although the Chinese economy has continued to see stable growth on the whole, relatively weak developments have been observed in part, as seen in the recent deceleration in the pace of improvement in business sentiment in the country's manufacturing sector. Whether this is due to the effects of the trade friction or a slowdown in domestic demand resulting from factors such as deleveraging is something that needs to be investigated. Meanwhile, the stock market has continued to be somewhat unstable. The fluctuations in the stock market are likely to be partly attributable to changes in perception of the various risk factors surrounding the global economy that I mentioned earlier. The Bank will continue to carefully examine developments in global financial markets and in the various underlying risk factors. II. Efforts toward Improving Productivity Robustness of the Economy As just explained, there are various risks surrounding the outlook for economic activity. As I will elaborate later, however, the robustness of the domestic and overseas economies to shocks appears to have increased. One of the reasons for this is the efforts made by firms so far, and I think that it is necessary for these efforts to continue further. Let me now focus on the efforts that firms have made so far toward improving productivity and outline how continuing improvement in productivity can be expected to boost the growth potential of Japan's economy and also address structural challenges such as the declining and aging population. At this meeting exactly a year ago, I brought up the problem of labor shortage and mentioned that Japan's economy can be expected to overcome this constraint and continue to grow. Firms have been making substantial progress so far in this regard. Amid the tightening of labor market conditions in the past few years, many firms have been actively undertaking labor-saving and efficiency-improving investment and streamlining business processes to establish more efficient business operations. These efforts have been boosted by the technological progress especially in information technology in recent years, as seen in the significant increase in software investment in sectors such as construction, retailing, as well as accommodations, eating and drinking services, where labor shortage is becoming acute (Chart 8). As just seen, positive efforts to improve labor productivity in response to the recent tightening of labor market conditions are spreading among many firms in Japan. However, quite a few firms have voiced doubt over the sustainability of economic growth going forward. Even though the longest economic recovery in the post-war era has been achieved and demand has increased to such a degree that firms suffer from labor shortage more acute than during the bubble period, not a few firms have expressed cautious views about the future. The recent increase in uncertainties surrounding overseas economies likely has led to a more cautious sentiment among firms to some extent. In addition, there is also a possibility that the experience of prolonged low growth and deflation makes such uncertainties appear greater. However, there is no need to fall into excessive pessimism for reasons I will now explain. First, let us take a look at overseas economies. Despite various risks, overseas economies have continued to grow firmly on the whole, with domestic demand in many economies continuing on an increasing trend. In the World Economic Outlook (WEO) released by the International Monetary Fund (IMF) in October, although forecasts were somewhat revised downward from the previous ones released in July, the annual real GDP growth rates for 2018 and 2019 are both projected to be 3.7 percent, continuing to mark relatively high growth close to the peak registered since the global financial crisis (Chart 9). As for the U.S. economy, prospects for the long-term growth potential have improved compared to some time ago. Another important point is that no overheating of the economy or notable financial imbalances have been observed. Although the economic recovery of the United States has continued for more than 110 consecutive months, which is longer than Japan's current recovery phase, so far no signs of the spread of a bubble can be detected. This is partly because the pace of growth has been moderate during this period and various financial regulations based on lessons learned from the global financial crisis have been put in place. Given these observations, the continuing stable growth of the U.S. economy -- the growth engine of the global economy -- provides substantial grounds for confidence in Japan's economy as well. Second, the diversification of growth sectors of Japan's economy is also an important factor enhancing the robustness of the economy. I mentioned earlier that services exports have made a substantial contribution to growth in external demand, while investment in structures has significantly contributed to growth in fixed capital formation, and such well-balanced growth is likely to raise the resilience of Japan's economy to future shocks. Third, a point worth mentioning is that the profitability of Japanese firms has improved. Even more than the level of corporate profits, what is important in this context is the nature of these profits. While corporate profits have been improving over the past six years, until around 2016, the main reason was the decline in crude oil prices. Meanwhile, sales volumes did not increase very much and turnover also remained more or less flat (Chart 10). It is said that profit improvements taking this form are unlikely to spur active and forward-looking behavior such as increases in business fixed investment. However, over the past two years or so, the nature of the improvements in profits has changed in that they have been accompanied by increases in sales volumes and turnover. This indicates that firms can have greater confidence in their profits, which is more likely to lead to increases in business fixed investment. Future Prospects Based on the observations I just highlighted, even if there were some kind of shock, Japan's economy and the global economy likely are sufficiently robust to withstand it. Under these circumstances, with firms continuing to actively make efforts toward improving productivity, it can be expected that the various concerns will be gradually resolved as Japan's economy continues to grow in a sustainable manner. Needless to say, labor productivity is defined as the value added per unit of labor input and represents the earning power per worker or unit of labor input such as the hourly labor input. As can be seen from this definition, raising labor productivity can be divided into two parts: efforts to save labor input, which is the denominator; and efforts to increase value added, which is the numerator. As I mentioned earlier, in the past few years, Japanese firms have made efforts to reduce labor input through such measures as labor-saving investment, reflecting the tightening of labor market conditions. Such efforts have been particularly pronounced in the nonmanufacturing sector, where there remains substantial room for productivity improvements compared to other economies. In fact, Japan is exhibiting the highest pace of growth in labor productivity among G7 countries (Chart 11). In order to further improve labor productivity, it is important to increase value added, which is the numerator of labor productivity. To this end, it is necessary to further create and exploit potential demand. Examples of the successful creation of new demand are provided by products in which Japan has an advantage such as cosmetics or sake (rice wine). Domestic sales of these products to tourists visiting Japan have led to repeat sales abroad when the tourists returned home, leading to an increase in turnover. In addition, the diversification and advances in housekeeping services, security services, and household electrical appliances can be regarded as creating demand stemming from the rapid increase in dual-working and senior households. Furthermore, new technologies such as rapidly advancing artificial intelligence (AI) and big data are likely to be powerful tools to exploit potential demand that otherwise cannot be captured. For example, the development of new means of transportation through self-driving systems and the provision of preventive medical services using real-time data of people's health condition have been attracting attention as businesses with future potential that did not exist before. Naturally, there is no specific method to create and exploit potential demand, and it can be said that innovative efforts play an important role. One of the things needed to this end is securing imaginative and creative human capital. While there are a number of key points to securing human capital -- such as creating appropriate work environments including via working-style reforms -- increasing wages through sustainable productivity improvements is another important point. Pushing ahead with labor-saving investment in response to the labor shortage ultimately is likely to help to grasp opportunities to capture new demand through increasing wages and securing superior human capital. For firms engaged in creating and exploiting such potential demand, the government's growth strategy and structural reforms offer great opportunities. The Bank is actively supporting firms' investment activities by maintaining highly accommodative financial conditions through powerful monetary easing. I would like firms to take advantage of this excellent environment and continue to pursue efforts toward improving productivity. The ultimate driver of economic growth is the animal spirit of firms. We hope to achieve sustainable growth of Japan's economy as a whole, with the government, the Bank, and firms working together as one. III. The Bank's Conduct of Monetary Policy Lastly, I will talk about the Bank's monetary policy. As stipulated by the Bank of Japan Act, the Bank's monetary policy conduct "shall be aimed at achieving price stability, thereby contributing to the sound development of the national economy." Based on this, the Bank has set a price stability target of 2 percent and conducts monetary policy with the aim of creating a virtuous cycle in the economy in which the inflation rate rises moderately along with increases in corporate profits, employment, and wages. While the government's growth strategy and flexible fiscal policy should provide strong support to achieve such sustainable economic growth, the Bank's stance to fulfill its role and do its utmost to achieve the price stability target has remained and will remain unchanged. Of course, as experience shows, the economic and price situation can change as a result of a range of factors. Therefore, in fulfilling its mandate, the Bank needs to pursue the monetary policy that is most appropriate to the situation at the time while weighing up its benefits and costs. This view is held not only by the Bank of Japan but is shared by central banks worldwide and will not change regardless of the kind of policy measures adopted. When the Bank introduced quantitative and qualitative monetary easing (QQE) six years ago, Japan's economy was not recovering and the year-on-year rate of change in the CPI was negative, far from the price stability target of 2 percent. Under these circumstances, the benefits of adopting bold monetary easing measures significantly outweighed the costs. The Bank therefore judged it appropriate to take drastic measures focusing on achieving the price stability target of 2 percent at the earliest possible time and embarked on bold measures that were substantially different from those in the past, such as the significant expansion of the monetary base. Such powerful monetary easing likely played a role in the substantial improvement of Japan's economy. On the price front, the economy already is no longer in deflation in the sense of a sustained decline in prices. However, prices have continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and it is still taking time to achieve the price stability target. Moreover, recently, downside risks mainly regarding overseas economies have come to warrant further attention. In this somewhat complicated situation, what is required is to persistently continue with the current powerful monetary easing while taking account of both the positive effects and the side effects -- that is, the benefits and costs -- of monetary easing in a balanced manner. This is exactly the kind of situation in which policy sustainability and durability is important. Let me elaborate. In terms of positive effects, it is necessary to maintain a positive output gap -- a driver for inflation -- for as long as possible under the current framework of "QQE with Yield Curve Control" and thereby firmly sustain the momentum toward 2 percent inflation. At the July Monetary Policy Meeting (MPM), the Bank introduced forward guidance for policy rates and made clear that it would "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time." This is also a measure that clarifies the Bank's policy stance of continuing with the current powerful monetary easing. On the other hand, in order to strengthen the sustainability and durability of this powerful monetary easing, the side effects of the policy also warrant attention. In the first half of this year, it was pointed out that the functioning of the Japanese government bond (JGB) market had deteriorated under the Bank's large-scale JGB purchases, as seen, for example, in somewhat rigid interest rate formation. Therefore, at the July MPM, the Bank also decided to conduct market operations and asset purchases in a more flexible manner. As a result, the degree of market functioning has improved, with JGB yields moving upward and downward again in tandem with stock prices and U.S. interest rates. In addition, the Bank is aware that prolonged downward pressure on financial institutions' profits, with the low interest rate environment and severe competition among financial institutions continuing, could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. Although these risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases, it is necessary to pay close attention to future developments, including from the perspective of maintaining policy sustainability and durability. As explained, the Bank will proceed step by step toward achieving the price stability target under the powerful monetary easing while taking into account in a balanced manner not only the benefits of monetary easing but also its costs. It is likely to take more time than expected to achieve the price stability target, and uncertainties regarding the outlook have heightened further. However, firmly maintaining the momentum toward achieving 2 percent inflation through such policy conduct will ultimately help to ensure the price stability target is achieved at the earliest possible time without putting an excessive burden on the real economy and the functioning of financial intermediation. Conclusion It seems that we are almost out of time. Today, I looked back on the economic recovery over the past six years and talked in some detail about firms' efforts toward improving productivity so far and future prospects. I also touched upon the possibility that responding to the recent labor shortage and actively proceeding with measures such as labor-saving investment will ultimately help firms to secure talented human capital and create and exploit new demand. The Bank will provide its utmost support for such efforts by firms through maintaining highly accommodative financial conditions. 2019 is the year of the boar in the Japanese Zodiac. While boars tend to have a reputation of heading to a target only in a bold way, experts say that they are brave and at the same time actually are extremely cautious animals. In 2019, the Bank will continue to steadily work toward achieving the price stability target. During the process, it will thoroughly examine various risks including those regarding developments in overseas economies. Although we should not be overly pessimistic, it is always necessary to calmly watch the surroundings. Based on this, the Bank will weigh up the benefits and costs of its policies and implement the policies most appropriate to the situation at the time. In little more than four months, the Heisei era will draw to a close and make way for a new era. Taking this juncture as an opportunity to look at Japan's economy from a broader perspective, the impact of the prolonged deflation of the past persists in the form of cautious wage setting and a reluctance to accept price rises. At the same time, however, the cautious attitude on the part of firms and households has been dissipating slowly but steadily on the back of the economic expansion and tight labor market conditions over the past few years. In the new era that is about to start, the Bank will continue to firmly fulfill its responsibility as the central bank in order to ensure the achievement of the price stability target and contribute to sustainable economic growth. I would like to close my speech by expressing my sincere hope that the year 2019 will be a wonderful one for all of you. Thank you for your attention. Japan's Economic and Price Developments and Future Prospects Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo December 26, 2018 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Japan's Economic and Price Developments II. Efforts toward Improving Productivity III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Japan's Economic and Price Developments Japan's Economy Real GDP Output Gap s.a., ann., tril. yen % Excess demand -2 -4 Excess supply -6 CY 00 -8 CY 00 Notes: 1. Shaded areas indicate recession periods. Notes: 2. The output gap is based on BOJ staff estimations. Sources: Cabinet Office; Bank of Japan. Chart 2 I. Japan's Economic and Price Developments Well-Balanced Economic Recovery (by Industry) Business Conditions DI (Tankan) Comparison of Peaks in the Previous Prolonged Economic Recovery Phase with Current Levels Manufacturing and Nonmanufacturing DI ("favorable" - "unfavorable"), % points DI ("favorable" - "unfavorable"), % points Manufacturing Nonmanufacturing Manufacturing -10 "Favorable" Peak during Previous Prolonged Recovery Current Recovery (CY 2018 Average) Iron and steel Motor vehicles General-purpose, production and business oriented machinery Ceramics, stone and clay Construction -12 Retailing -3 Wholesaling Transport and postal activities Services for individuals -20 -30 -40 "Unfavorable" Nonmanufacturing -50 -60 CY 00 Notes: 1. Shaded areas in the left chart indicate recession periods. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Notes: 2. The figure for the peak during the previous prolonged recovery for "general-purpose, production and business oriented machinery" in the right chart is that for "industrial machinery." Source: Bank of Japan. Chart 3 I. Japan's Economic and Price Developments Well-Balanced Economic Recovery (by Enterprise Size and Area) Business Conditions DI by Enterprise Size (Tankan) Active Job Openings-to-Applicants Ratio by Area DI ("favorable" - "unfavorable"), % points 1.8 s.a., ratio Large enterprises Three metropolitan areas 1.6 Small enterprises Nonmetropolitan areas 1.4 1.2 1.0 -10 "Favorable" 0.8 -20 0.6 -30 0.4 -40 "Unfavorable" 0.2 -50 -60 CY 00 0.0 CY 85 Notes: 1. Shaded areas indicate recession periods. Notes: 2. In the left chart, there is a discontinuity in the data in December 2003 due to a change in the survey framework. Notes: 3. In the right chart, "three metropolitan areas" refer to the Tokyo area (Tokyo, Kanagawa, Saitama, Chiba, and Ibaraki prefectures), the Osaka area (Osaka, Hyogo, Kyoto, and Nara prefectures), and the Nagoya area (Aichi and Mie prefectures). "Nonmetropolitan areas" are areas other than the three metropolitan areas. Figures for 2018/Q4 are those for October. Sources: Ministry of Health, Labour and Welfare; Bank of Japan. Chart 4 I. Japan's Economic and Price Developments Diversification in Exports Previous Prolonged Economic Recovery Phase (February 2002 – February 2008) change from CY 2001, real, tril. yen Current Economic Recovery Phase (December 2012 –) change from CY 2012, real, tril. yen Goods Services Exports Goods Services Exports -5 -5 CY 01 Note: Figures for 2018 are Q1 - Q3 averages on a seasonally adjusted annualized basis. Source: Cabinet Office. CY 12 Chart 5 I. Japan's Economic and Price Developments Diversification in Investment in Tangible Assets (Fixed Capital Formation) Previous Prolonged Economic Recovery Phase (February 2002 – February 2008) Current Economic Recovery Phase (December 2012 –) change from CY 2001, real, tril. yen Machinery and equipment, etc. Buildings and structures Total change from CY 2012, real, tril. yen Machinery and equipment, etc. Buildings and structures Total -5 -5 -10 -10 -15 -15 -20 -20 CY 01 CY 12 Note: Figures for 2018 are Q1 - Q3 averages on a seasonally adjusted annualized basis. Source: Cabinet Office. Chart 6 I. Japan's Economic and Price Developments Consumer Prices y/y % chg. 2005 base 2015 base 2010 base -1 CPI (all items less fresh food) -2 CPI (all items less fresh food and energy) -3 CY 01 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 7 I. Japan's Economic and Price Developments Recent Exports of Goods, Production, and Number of Foreign Visitors Real Exports s.a., CY 2015=100 Number of Foreign Visitors to Japan Industrial Production s.a., CY 2015=100 s.a., ann., mil. persons CY 10 11 12 13 14 15 16 17 18 CY 10 11 12 13 14 15 16 17 18 CY 10 11 12 13 14 15 16 17 18 Notes: 1. The figure for real exports for 2018/Q4 is the October-November average. Notes: 2. The figure for industrial production for 2018/Q4 is that for October. Notes: 3. The figure for the number of foreign visitors to Japan for 2018/Q4 is the October-November average. Seasonally adjusted figures are BOJ staff estimates. Sources: Ministry of Finance; Ministry of Economy, Trade and Industry; JAPAN NATIONAL TOURISM ORGANIZATION; Bank of Japan. Chart 8 II. Efforts toward Improving Productivity Progress in Labor-Saving Investment Software Investment (Tankan) Employment Conditions DI (Tankan) -80 -70 -60 -50 -40 reversed, DI ("excessive" - "insufficient"), % points "Insufficient" All industries All industries Construction Retailing Accommodations, eating and drinking services FY 2005 = 100 Construction Retailing Accommodations, eating and drinking services -30 -20 -10 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Note: Figures for software investment for fiscal 2018 are based on plans in the December 2018 survey. Source: Bank of Japan. FY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Chart 9 II. Efforts toward Improving Productivity Global Economy Potential Growth Rate of the U.S. Economy (Estimates) Growth Rate of the Global Economy IMF's outlook (as of October 2018) y/y % chg. 3.8 2.2 3.7 y/y % chg. 3.7 3.7 As of August 2018 2.0 As of June 2017 3.6 1.8 3.5 1.6 3.4 1.4 3.3 1.2 3.2 1.0 3.1 3.0 CY 12 0.8 CY 10 Sources: IMF; CBO. Chart 10 II. Efforts toward Improving Productivity Changes in Corporate Profits Profitability Profits and Sales s.a., % tril. yen Ratio of current profits to sales tril. yen 1,450 Current profits (left scale) Ratio of operating profits to sales Sales (right scale) 1,400 1,350 1,300 CY 00 CY 12 1,250 Notes: 1. Based on the Financial Statements Statistics of Corporations by Industry, Quarterly. Excluding "finance and insurance." Figures from 2009/Q2 exclude "pure holding companies." Notes: 2. Shaded areas in the left chart indicate recession periods. Notes: 3. Figures for 2018 in the right chart are Q1 - Q3 averages on a seasonally adjusted annualized basis (BOJ staff estimates). Source: Ministry of Finance. Chart 11 II. Efforts toward Improving Productivity International Comparison of Labor Productivity Growth Rate of Labor Productivity 1.4 ann., y/y % chg. (CY 2010-2017 average) 1.2 Level of Labor Productivity CY 2017, U.S.=100 1.0 0.8 0.6 0.4 0.2 0.0 Note: The charts are based on PPP-adjusted real labor productivity per hour. Source: Conference Board.
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the G20 Finance and Central Bank Deputies Meeting, Tokyo, 17 January 2019.
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January 17, 2019 Bank of Japan Opening Remarks at the G20 Finance and Central Bank Deputies Meeting Haruhiko Kuroda Governor of the Bank of Japan Good afternoon. It is a great honor for me to work with you and to serve as co-chair with Minister Aso at the G20 Finance Ministers and Central Bank Governors Meetings this year. The G20 was established in 1999, twenty years ago. It was the year when the euro was introduced and two years after the Asian Financial Crisis. I attended the inaugural meeting in Berlin as Vice-Minister of Finance for International Affairs. The main objective of the G20 was to promote cooperation among systemically significant economies including emerging market economies, in order to achieve stable and sustainable global growth. Later, the leaders' summit was initiated in response to the global financial crisis in 2008, and the G20 played a significant role in coordinating policy responses to the crisis. Since then, as the world economy has recovered from the crisis, the G20 has discussed a wide range of issues to promote strong, sustainable, balanced, and inclusive growth. While the role and agenda of the G20 have evolved over time, I would like to point out three important values that have been emphasized consistently, based on my long-time involvement in the G20 since its inauguration. First, we recognize that the expansion of cross-border transactions of goods, services, and finance will benefit all countries. We need to conduct policies so that many people can enjoy the positive effects of international trade and capital flows on growth and productivity gains, while minimizing their potential negative impacts. Second, we need to be forward-looking in preparing for policy responses to medium- to long-term challenges. For instance, under Japan's presidency this year, we will discuss policy responses to aging. Japan is currently the most aged society in the world. Sooner or later, however, other economies will face a similar situation. Many issues must be considered in our efforts to cope with an aging society, including fiscal, monetary, and structural policies. I believe the G20 provides a valuable forum for discussion and mutual understanding of these issues. Third, we value the importance of inclusive growth, that is, the dividends of economic growth should be distributed fairly and equally across the whole society. The G20 has discussed policy agendas to enhance the overall living standards of low-income countries in a sustainable manner. In addition, we need to address the increasing inequality in advanced economies as well, taking account of the recent developments. I hope you will have fruitful discussions at this two-day meeting and subsequent meetings of the G20, leading up to the Finance Ministers and Central Bank Governors Meeting in Fukuoka in June. I look forward to meeting you all again later this year. Thank you for your attention.
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Opening remarks by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the G20 Symposium, Tokyo, 17 January 2019.
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January 17, 2019 Bank of Japan Opening Remarks at the G20 Symposium in Tokyo Masayoshi Amamiya Deputy Governor of the Bank of Japan Good morning, G20 finance and central bank deputies, professors, and distinguished guests. Welcome to Tokyo. This year, Japan assumes the G20 presidency for the first time. Today's symposium is one of the kick-off events under Japan's presidency. On behalf of the co-organizers, the Bank of Japan and the Japanese Ministry of Finance, I would like to express our sincere gratitude for your participation in this symposium. As one of the medium- to long-term policy issues that will be discussed under Japan's G20 presidency, we chose "aging and its policy implications." The G20 had some opportunities in the past to discuss aging in the context of other policy issues such as growth strategies and global imbalances. This year, we have decided to focus on aging itself and discuss it in a comprehensive manner for two reasons. First, aging is a common policy challenge for all G20 members. Currently, Japan is the most aged country among the G20 membership. However, it is almost certain that in many other G20 countries, including emerging economies, the ratio of elderly people will increase in the future. Aging and shrinking populations can have a huge impact on a country's economic activity and the distribution of its output. They also have a substantial impact on the flow of capital and labor between countries at different stages of aging. Moreover, labor market conditions, social security systems, and economic policies are different across countries, and these affect each country's economic activity and social welfare in different ways. Therefore, it is essential that we share our experiences and deepen our understanding of where the problem lies and how policies can address it. Above all, since future demographic changes can be predicted with some degree of certainty, we can prepare policy responses to their medium- to long-term trends in advance through constructive discussion. The second reason for our focus on aging is that its impact on the economy will differ depending on policy responses. Aging is an important risk factor for the economy in that it can negatively affect future economic activity. However, given the appropriate policy responses, it can also have a positive impact on the economy. In the first place, longevity is surely to everyone's benefit. The fact that we can live longer in good health has been achieved through human endeavor in fields such as medical technology and in the spread of education. Economic policies and institutions must be adapted so that these achievements can improve the economic welfare of everyone, including future generations. This is exactly our responsibility as policymakers. Based on these thoughts, we titled this symposium: "For a Better Future: Demographic Changes and Macroeconomic Challenges." The symposium focuses on demographic changes over three sessions: first, the impacts on the macro economy, second, the impacts on fiscal conditions and the social security system, and finally, the impacts on monetary policy and the financial system. In each session, leading scholars and policymakers will provide the latest knowledge and identify the most relevant issues. In the discussions that follow, a broader and deeper understanding of the issues will be shared by all participants. I believe this will provide valuable input to the policy discussion at the subsequent G20 meetings. I hope you will all enjoy, contribute to and benefit from active and constructive discussions. Thank you very much for your attention.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Yamaguchi, 31 January 2019.
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January 31, 2019 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Yamaguchi Masayoshi Amamiya 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 Yamaguchi Prefecture. I also would like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's Shimonoseki Branch. At the Monetary Policy Meeting (MPM) held last week, the Bank updated its projections for Japan's economic activity and prices through fiscal 2020 and released them in the January 2019 Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to explain the Bank's outlook for Japan's economic activity and prices as well as the recent conduct of monetary policy, while outlining the Outlook Report. I. Financial and Economic Developments The stock and foreign exchange markets saw large fluctuations at the start of this year. The Nikkei 225 Stock Average marked the highest level seen for the first time in 27 years in October last year but thereafter decreased substantially in late December through the beginning of January. In the foreign exchange market, the U.S. dollar/yen rate continued to be relatively stable throughout the second half of last year, being in the range of 110-115 yen; however, it dipped briefly to the range of 104-105 yen in the early morning of January 3 amid the low trading volume in the market. Thereafter, although stock prices recovered to the 20,000 yen level and the U.S. dollar/yen rate returned to the range of 109-110 yen through mid-January, financial markets both at home and abroad have remained volatile (Chart 1). However, as I will explain later, the real economies of Japan as well as the United States and Europe have continued to recover steadily on the whole so far, and the outlook for corporate profits has remained firm. Therefore, developments in financial markets in the meantime may partly reflect market participants responding somewhat sensitively to heightening uncertainties regarding the outlook. At the same time, however, it is said that financial markets act as a mirror that reflects the real economy. Thus, it is important to carefully examine economic developments while also bearing in mind the signals emitted by financial markets. In what follows, I would first like to explain the current situation of and outlook for Japan's economy, and then examine the risks to the outlook, particularly regarding developments in overseas economies. To begin with, I will talk about economic developments in Japan. The economy is expanding moderately, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. In order to grasp the overall picture of economic activity, let us first take a look at an indicator called the output gap, which represents the balance between demand and supply in the economy as a whole (Chart 2). While a positive output gap shows excess demand and a negative output gap indicates excess supply, the gap has been clearly positive over the past two years. Under these circumstances, the current economic recovery phase, which began in December 2012, has already lasted for a long period of about six years, almost reaching the longest post-war recovery on record. Next, let me explain developments by economic entity. In the corporate sector, exports and production have maintained their increasing trend (Chart 3). Although they were pushed down by the successive natural disasters in the July-September quarter last year, such effects were only temporary, and exports and production have turned to an increase since October. In this situation, corporate profits have been at high levels and business fixed investment has continued on an increasing trend (Chart 4). Looking at fixed investment by sector, in manufacturing, there has been a notable increase in research and development investment in cutting-edge technologies such as self-driving systems and artificial intelligence (AI), in addition to investment intended for enhancing capacity. In nonmanufacturing, investment also has been increasing in a wide range of fields, such as that in office buildings accompanying urban redevelopment projects and in the construction of accommodation facilities to meet demand from inbound tourism. Investment aimed at improving efficiency and saving labor in order to deal with the recent labor shortage also has maintained its high growth nationwide. Such improvement in the corporate sector has had positive effects on the household sector. In the labor market, the active job openings-to-applicants ratio has been at a high level last seen during the period of high economic growth, and the unemployment rate has declined to around 2.5 percent, the level observed during the bubble period (Chart 5). Total cash earnings per employee have risen moderately but steadily. Against the background of improvement in the employment and income situation, private consumption also has been increasing moderately, albeit with fluctuations. With regard to the outlook, Japan's economy will likely continue on an expanding trend. The Bank projects that the economy will continue growing at an annual pace of around 1 percent throughout the projection period -- that is, through fiscal 2020. The pace is about the same as the growth rate of Japan's economy that can be achieved in the long term, or the so-called potential growth rate, which the Bank estimates to be nearly 1 percent. Our main scenario is that Japan's economy will maintain its firm growth for the time being, at a pace consistent with its potential (Chart 6). However, due attention should be paid to the fact that downside risks to this scenario have been heightening, particularly regarding developments in overseas economies. The baseline scenario of the outlook for overseas economies at this point is that these economies are expected to continue growing firmly on the whole. Meanwhile, there are differences in growth rates among regions compared to the synchronous growth of the global economy observed through the first half of last year, and uncertainties regarding the outlook have been heightening. Similar views have been presented by international organizations and major central banks. According to the latest forecasts released by the International Monetary Fund (IMF) this month, the global economy is projected to register relatively high annual growth of around 3.5 percent in 2019 and 2020. However, these forecasts have been somewhat revised downward from the previous ones released in October 2018 (Chart 7). In addition, the IMF also has pointed out that the global economy is faced with downside risks, mainly due to the effects of the trade friction between the United States and China. With regard to this friction, negotiations have continued between the two countries since the turn of 2019, but it remains difficult to project developments. Going forward, the effects may spread, not only through a direct impact on trade activities in various economies, but also factors such as a deterioration in firms' fixed investment stance and risk sentiment in global financial markets. In addition, an increasing number of developments imply that the Chinese economy is decelerating recently, reflecting not only the effects of the trade friction but also of factors such as authorities' measures to prevent overheating on the credit side. Taking into account the timely conduct of fiscal and monetary policy by China, the risk that the growth pace of the Chinese economy will decelerate substantially is judged to be small. However, as Japan -- including Yamaguchi Prefecture -- has strong economic relations with China, we will monitor developments in the Chinese economy carefully. In addition, there are various other risks originating from overseas economies. Although it is a positive factor that capital outflows from some emerging economies such as Turkey and Argentina -which were a matter of concern a while ago -- have calmed recently, uncertainties remain concerning developments in negotiations on the United Kingdom's exit from the European Union (EU). Against the background of such heightening uncertainties regarding overseas economies, financial markets have remained unstable, as I mentioned at the outset. The Bank will continue to carefully monitor developments in the domestic and overseas markets, including the effects on firms' and households' sentiment. II. Price Developments Next, I will move on to price developments. The year-on-year rate of change in the consumer price index (CPI) in Japan remained in negative territory for 15 years from the late 1990s, with brief exceptions (Chart 8). In order to make a breakthrough in this situation, the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013, embarking on unprecedentedly powerful monetary easing. Since then, Japan's economy has improved significantly, and on the price front, the year-on-year rate of change in the CPI excluding energy and fresh food generally has been in positive territory for about five years. The economy is no longer in deflation, in the sense of a sustained decline in prices. This trend can be observed in firms' price- and wage-setting stance. According to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan), the situation recently has come to take hold in which the proportion of enterprises answering that the output prices have risen exceeds the proportion of those answering that such prices have fallen. This occurred for the first time in about 30 years since the bubble period (Chart 9). Also, on the wage side, the practice of regular increases in base pay, which had disappeared under deflation, returned in 2014 and has taken hold again since then. Moves to increase wages have been spreading steadily, not only among large firms but also small and medium-sized firms in local areas. In relation to this point, the Bank compiled the results of interviews conducted by its branches in the annex paper to the Regional Economic Report released in December, in which it introduced comments by firms in this region as well, such that there was a notable number of firms that were proceeding with wage increases in order to secure employees. Thus, firms' stance has shifted toward further raising wages and prices, and as such developments continue, the year-on-year rate of change in the CPI is likely to increase toward the price stability target of 2 percent (Chart 6). However, the pace of improvements in wages and prices has remained more moderate than expected. The year-on-year rate of change in the CPI has been positive but has stayed in the range of 0.5-1.0 percent, continuing to show relatively weak developments compared to the economic expansion and the labor market tightening. This is likely to be mainly due to two reasons (Chart 10). The first is that prices have not responded smoothly to excess demand stemming from the economic expansion. Theoretically, when demand exceeds supply, there will be shortage of labor and products, leading to increases in wages and prices. As I explained earlier, such increases actually have been observed, mainly for wages, but the pace has been slow compared to that of economic improvement. In particular, the rate of increase in scheduled cash earnings of regular employees has been sluggish, and it has been taking time for a rise in their wages to fully take hold. The year-on-year rate of increase in hourly wages of part-time employees, which are sensitive to developments in labor market conditions, has continued to mark relatively high growth of around 2.5 percent. However, prices in the services sector, which is highly dependent on part-time employees, also have not risen clearly. Regarding the reason why firms can avoid price rises despite the increase in labor costs, it has been pointed out that, in mainly the nonmanufacturing sector in Japan, there is large room to absorb an increase in labor costs by raising labor productivity, primarily through labor-saving investment. Technological progress such as digitalization in recent years also has partly contributed to encouraging firms' efforts to raise productivity. Thus, even amid the economic expansion, there is a combination of various factors that makes it difficult for wages and prices to rise. It has been taking time to resolve these factors and such downward pressure on prices may last longer than expected. The second reason why price rises have been sluggish is that inflation expectations have not risen easily. Inflation expectations refer to the outlook for prices that firms and households assume in carrying out economic activity, or in other words, people's mindset toward prices. Inflation expectations and the actual inflation rate affect each other. For example, if current prices rise, firms expect that such a rise will continue in the future and consider raising prices of goods and services that they produce and sell. In addition, if households expect future inflation, they are likely to request wage increases in line with it. Thus, in order to achieve the price stability target of 2 percent, people's mindset based on the assumption that prices will not increase easily -- which became entrenched under prolonged deflation -needs to change. However, inflation expectations have been more or less unchanged so far despite moderate inflation, and it has been taking time for people's mindset toward prices to change, or in other words, for the deflationary mindset to be dispelled. I would like to add one point regarding prices. In terms of the outlook for prices from fiscal 2019 onward, some institutional factors that will have certain effects on the CPI are assumed, including the scheduled consumption tax hike in October 2019 and policies concerning the provision of free education. Moreover, a reduction in charges for mobile phone services that is expected in the future also is likely to influence the CPI. Regarding these issues, two points hold the key from the viewpoint of monetary policy conduct. First, what is important is not temporary price fluctuations but the underlying trend in prices. On this point, the factors that were raised earlier can be characterized as temporary shocks, and as long as this is the case, their impact on the underlying trend in prices as well as monetary policy conduct can be assessed as small. Second, having said that, these shocks may not just remain temporary depending on the situation. As I mentioned earlier, there is a possibility that people's inflation expectations will move upward and downward in line with price fluctuations, thereby affecting the underlying trend in prices. Giving due consideration to these points, the Bank will assess future price developments and communicate developments in such special factors to the public in an appropriate manner. III. The Bank's Conduct of Monetary Policy Now, I would like to explain the Bank's conduct of monetary policy. As I have talked about so far, prices have continued to show relatively weak developments compared to the economic expansion and it is also taking more time than expected for inflation expectations to rise. I feel that an extended period of time is needed for a change in people's mindset toward prices, which was formed under prolonged low growth and deflation. Moreover, we are in a situation where we also need to pay more attention to the accumulation of side effects accompanying monetary easing. In order to achieve the price stability target under such financial and economic developments, the Bank recognizes that it is important to persistently continue with the current powerful monetary easing and thereby maintain a positive output gap -- a driver for inflation -- for as long as possible. Based on such thinking, the Bank made two main policy decisions at the July 2018 MPM. First, with a view to clarifying its stance to persistently continue with the current powerful monetary easing, the Bank introduced forward guidance for policy rates (Chart 11). This is a policy measure that strengthens market confidence and expectations regarding the continuation of monetary easing by making clear future policy rates in advance. Specifically, the Bank made clear that it would "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike." Second, the Bank implemented measures to enhance policy sustainability and durability. In order to persistently continue with the current powerful monetary easing, it is necessary to contain the accompanying negative effects, or the side effects. In the first half of last year, there was a growing concern that the functioning of the Japanese government bond (JGB) market had deteriorated under the Bank's large-scale JGB purchases, as seen, for example, in rigid interest rate formation. In view of this situation, at the July 2018 MPM, the Bank decided to conduct market operations and asset purchases in a more flexible manner. Regarding JGB purchases, while the target level of the long-term yields was maintained at around zero percent, the Bank made clear that the actual yields might move upward and downward to some extent mainly depending on developments in economic activity and prices. In addition, as for purchases of exchange-traded funds (ETFs), the Bank clarified that it might increase or decrease the amount of purchases depending on market conditions while maintaining the annual pace of increase in the amount outstanding of about 6 trillion yen. Half a year has passed since the policy decision was made last July. It can be confirmed that the intended effects of alleviating the side effects have been achieved, and that the policy decision also has been effective to a certain extent in stabilizing financial markets. Before the introduction of forward guidance, quite a few market participants held the view that the Bank would raise policy rates in the near future, which led to market instability in some cases. Since the July MPM, such view has dissipated rapidly, and the Bank's stance of continuing with powerful monetary easing has prevailed further. Moreover, the degree of JGB market functioning has improved, as seen, for example, in transactions gradually having become more active and price movements having increased. 10-year JGB yields rose temporarily after the policy decision in July; however, they then fell into negative territory and recently have been stable at around the target level of around zero percent. The pace of ETF purchases on an annual basis was around 2 trillion yen in August last year, while such purchases marked a high pace of around 10 trillion yen in October and December, when the markets fluctuated significantly. Such flexible purchases likely have had the effect of alleviating market instability in the meantime. Regarding the effects brought about by powerful monetary easing, its relation to financial institutions' profits and the functioning of financial intermediation is often discussed. The Bank is fully aware that prolonged downward pressure on financial institutions' profits, with the low interest rate environment and severe competition among financial institutions continuing, could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. Although these risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases, the Bank will continue to make efforts to grasp the latest situation through its on-site examinations and off-site monitoring of financial institutions and encourage them to take concrete actions as necessary. As I have outlined so far, the Bank will pursue powerful monetary easing while thoroughly examining both the benefits and costs of its policy effects. In doing so, 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. Conclusion To conclude, I would like to talk about the economy of Yamaguchi Prefecture. Despite the temporary effects of disasters such as the heavy rain last year, which mainly affected western Japan, the Bank judges that the economy of Yamaguchi Prefecture thereafter has been recovering moderately but steadily. There is an accumulation of manufacturing industries in the prefecture, mainly along the coast of the Seto Inland Sea, and production and exports have been at high levels, led by chemicals and transport equipment, where there is favorable demand for high value-added products. Mainly against the background of these positive developments in production, business fixed investment also has increased. In addition, in terms of tourism, the number of domestic and foreign tourists has been on an uptrend, partly because tourist attractions have become more famous, mainly owing to the blessed natural landscape. Under these circumstances, labor market conditions in the prefecture have tightened further, as evidenced by the active job openings-to-applicants ratio having been at around the levels seen during the bubble period. According to interviews conducted by the Bank's Shimonoseki Branch, labor shortage was pointed out by a wide range of firms, regardless of industry. In response to this, I heard that administrative bodies and economic organizations in the region were providing various support programs, such as for job seekers who live outside the prefecture. Firms also have been undertaking labor-saving investment and reviewing working conditions in line with the diversification of workers' needs. Such active efforts by the public and private sectors are essential in order for the prefecture's economy to overcome the challenge of labor shortage and achieve sustainable economic growth. In the Edo era, Kokudaka -- land value expressed in terms of the estimated amount of rice production -- of the Chōshū clan in the former Yamaguchi Prefecture was about 369,000 koku, which was not necessarily top class. Despite that fact, the Chōshū clan played an important role in the great achievement of the Meiji Restoration. It is often said that this is because the prefecture turned out many prominent individuals and had strong economic power that substantially outweighed its Kokudaka. The Chōshū clan gathered all its force to powerfully promote industries and made efforts to boost production of local specialties such as rice, paper, salt, and wax -- the so-called Bōchōyonpaku. Furthermore, in Shimonoseki, which was an important place for maritime traffic, an institution called Koshinikata managed by the clan was established. Together with merchants in the prefecture, the clan actively developed businesses with those on the ships that passed by. These various leading efforts significantly enhanced the economic power of the Chōshū clan, and this became the driver for the Meiji Restoration. I heard that, since 2018, which marked the 150th anniversary of the Meiji Restoration, efforts have been made toward making Yamaguchi Prefecture full of vitality through meeting challenges to achieve restorations in three aspects: industry, interaction, and living. I would like to close my speech by expressing my hope that such positive joint efforts by the public and private sectors will lead to growth in existing firms and creation of new work places, and that the prefecture's economy thereby will grow further. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Yamaguchi January 31, 2019 Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction I. Financial and Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Financial and Economic Developments Developments in Financial Markets Foreign Exchange Markets Stock Markets 25,000 yen points Fluctuations in FX rate on January 3 yen/U.S. dollar 3,000 120 yen/U.S. dollar Yen/U.S. dollar Yen/U.S. dollar 2,900 24,000 2,800 23,000 2,700 22,000 2,600 21,000 2,500 Nikkei 225 Stock Average (left scale) 20,000 Sep. Dec. Yen depreciation Yen appreciation Yen appreciation 2,400 S&P 500 (right scale) 19,000 Sep. Dec. Mar. Jun. Yen depreciation 2,300 100 Sep. Dec. Mar. Jun. Sep. 6 12 18 0 6 12 18 0 6 12 18 Dec. o'clock Jan. 2 Jan. 3 Jan. 4 Sources: Bloomberg; Thomson Reuters. Chart 2 I. Financial and Economic Developments Japan's Economy Real GDP Output Gap s.a., ann., tril. yen % Excess demand -2 -4 -6 CY 08 Note: The output gap is based on BOJ staff estimations. Sources: Cabinet Office; Bank of Japan. -8 CY 08 Excess supply Chart 3 I. Financial and Economic Developments Exports and Production Real Exports Industrial Production s.a., CY 2015=100 s.a., CY 2015=100 CY 10 CY10 Note: The figure for industrial production for 2018/Q4 is the October-November average. Sources: Ministry of Finance; Ministry of Economy, Trade and Industry; Bank of Japan. Chart 4 I. Financial and Economic Developments Corporate Profits and Business Fixed Investment Business Fixed Investment Plans (December Tankan) Corporate Profits s.a., % s.a., ann., tril. yen Ratio of current profits to sales (all industries and enterprises, left scale) Private nonresidential investment (SNA, real, right scale) y/y % chg. Business fixed investment (including land purchasing expenses) -5 -10 -15 CY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -20 FY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 ▼R&D investment FY ＋ 3.4 y/y % chg. ＋ 3.6 Notes: 1. Figures for ratio of current profits to sales are based on the Financial Statements Statistics of Corporations by Industry, Quarterly (from 2009/Q2 exclude "pure holding companies"). Notes: 1. Excluding "finance and insurance." Notes: 2. Figures for business fixed investment (including land purchasing expenses) and R&D investment are based on the plans as of December Tankan in each fiscal year (all enterprises). Sources: Ministry of Finance; Cabinet Office; Bank of Japan. Chart 5 I. Financial and Economic Developments Employment Situation Active Job Openings-toApplicants Ratio 2.0 Unemployment Rate s.a., ratio s.a., % 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 CY 65 CY 65 Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 6 I. Financial and Economic Developments Outlook for Economic Activity and Prices (January 2019 Outlook Report) the medians of the Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) (Reference) Excluding the effects of the consumption tax hike and policies concerning the provision of free education Fiscal 2018 +0.9 +0.8 Forecasts made in October 2018 +1.4 +0.9 Fiscal 2019 +0.9 +1.1 +0.9 Forecasts made in October 2018 +0.8 +1.6 +1.4 Fiscal 2020 +1.0 +1.5 +1.4 Forecasts made in October 2018 +0.8 +1.6 +1.5 Note: The direct effect of the consumption tax hike on the CPI for fiscal 2019 and fiscal 2020 is estimated to be 0.5 percentage point for each year. The direct effects of policies concerning the provision of free education on the CPI for fiscal 2019 and fiscal 2020 are estimated to be minus 0.3 percentage point and minus 0.4 percentage point, respectively. Source: Bank of Japan. Chart 7 I. Financial and Economic Developments Overseas Economies Projections for Major Economies (IMF) y/y % chg., % points Projection 3.8 3.7 Advanced economies 2.4 2.3 United States 2.2 2.9 Euro area 2.4 1.8 Japan 1.9 0.9 4.7 4.6 China 6.9 6.6 ASEAN-5 5.3 5.2 Latin America and the Caribbean 1.3 1.1 World Emerging market and developing economies Projection 3.5 3.6 (-0.2) (-0.1) 2.0 1.7 (-0.1) (0.0) 2.5 1.8 (0.0) (0.0) 1.6 1.7 (-0.3) 1.1 (0.2) (0.0) 0.5 (0.2) 4.5 4.9 (-0.2) (0.0) 6.2 6.2 (0.0) (0.0) 5.1 5.2 (-0.1) (0.0) 2.0 2.5 (-0.2) (-0.2) Note: The post-2019 figures are based on January 2019 WEO projections. Figures in parentheses show the differences from the October 2018 projections. Source: IMF. Chart 8 II. Price Developments Consumer Prices y/y % chg. -1 CPI (all items less fresh food) -2 -3 CY 85 CPI (all items less fresh food and energy) Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 9 II. Price Developments Environment Surrounding Prices Output Prices DI (Tankan) DI ("rise" - "fall"), % points Large enterprises Small enterprises -10 -20 -30 -40 -50 CY 85 Note: There is a discontinuity in the data in December 2003 due to a change in the survey framework. Source: Bank of Japan. Chart 10 II. Price Developments Reasons for a Rise in Inflation Taking Time Supply Side Large room for firms to raise productivity Technological progress in recent years High wage elasticity of labor supply Mindset Experience of prolonged low growth and deflation The pace of improvement in prices and inflation expectations has remained slow compared to the improvement in the output gap. 1. Firms' cautious wage- and price-setting stance 2. Sluggish increase in households' tolerance of price rises 3. Intensifying competition III. The Bank's Conduct of Monetary Policy Chart 11 Strengthening the Framework for Continuous Powerful Monetary Easing (Decided on 31 July, 2018) Taking more time than expected to achieve the price stability target of 2 percent. Maintaining the output gap as long as possible within positive territory is appropriate. Persistently Continuing with Powerful Monetary Easing Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." ⇒ Strengthening the commitment to achieving the price stability target Enhancing the sustainability of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Long-term interest rate: The Bank maintains the target level of around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. Purchases of ETFs: The Bank maintains the annual pace of increase in the amount outstanding of about 6 trillion yen. While doing so, the Bank may increase or decrease the amount of purchases depending on market conditions. etc. 11 ■
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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, Yamanashi, 6 March 2019.
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March 6, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Yamanashi Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Kofu Branch. The Bank introduced quantitative and qualitative monetary easing -- or QQE for short -- in April 2013 with the aim of achieving the inflation target of 2 percent, and since then has strengthened the QQE framework. Today, I first would like to explain the achievements thus far of the Bank's monetary easing measures, excluding those regarding prices, and then describe recent developments in the economy and prices. I. The Achievements of Monetary Easing Improvements in Employment The first thing that should be mentioned as an achievement of monetary policy is the improvement in employment. 1 Chart 1 shows the number of regular and non-regular employees. As can be seen, at the start of QQE, it was primarily non-regular employment that increased. However, since around the beginning of 2015, regular employment also has expanded. Moreover, the share of non-regular employees (non-regular employees divided by all employees excluding executives), which had been rising, also has leveled off. Regarding how monetary easing lifts productivity, see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Ishikawa," Bank of Japan, July 2018. Chart 1 Employment Introduction of QQE mil. persons % Before QQE Regular employees -0.6% (annualized) Non-regular employees +1.5% (annualized) After QQE +1.1% +2.4% Feb. 1984 Feb. 86 Feb. 88 Feb. 90 Feb. 92 Feb. 94 Feb. 96 Feb. 98 Aug. 99 Aug. 2000 Aug. 01 02/Q2 02/Q4 03/Q2 03/Q4 04/Q2 04/Q4 05/Q2 05/Q4 06/Q2 06/Q4 07/Q2 07/Q4 08/Q2 08/Q4 09/Q2 09/Q4 10/Q2 10/Q4 11/Q2 11/Q4 12/Q2 12/Q4 13/Q2 13/Q4 14/Q2 14/Q4 15/Q2 15/Q4 16/Q2 16/Q4 17/Q2 17/Q4 18/Q2 18/Q4 Number of regular employees (both sexes) Number of non-regular employees (both sexes) Rate of non-regular employees (both sexes, right scale) Note: Regular employees and non-regular employees exclude executives of companies and corporations. The figures for "Before QQE" and "After QQE" show the annualized growth rates of employees from 2008/Q1 to 2013/Q1 and those from 2013/Q1 to 2018/Q4, respectively. Source: Ministry of Internal Affairs and Communications, "Labour Force Survey." Improvements in Employment of Women and the Elderly Chart 2 shows that the employment of both women and the elderly (those aged 65 years and over) has been growing. Nevertheless, despite women's entry into the labor market, most women work part-time, and I am well aware of the criticism that there are few women in top positions in Japan. According to the World Economic Forum's Global Gender Gap Index (2018), which measures the degree of gender equality, Japan ranks only 110th among 149 countries. However, some progress is being made. As can be seen in Chart 2, the number of women in regular employment has been increasing. Moreover, the proportion of women who are non-regular employees, which had been rising, has remained flat since the start of QQE. This means that the number of women gaining experience at work and moving into managerial positions also should increase. In fact, the share of managerial positions occupied by women has been on a rising trend.2 Chart 2 Employment of Women and the Elderly mil. persons Introduction of QQE % Before QQE After QQE Non-regular employees (female) +1.2% (annualized) +2.6% Regular employees (female) +0.2% (annualized) +2.0% Before QQE After QQE Non-regular employees (both sexes, aged 65 years and over) +5.7% (annualized) +12.1% Regular employees (both sexes, aged 65 years and over) +3.7% (annualized) +6.9% Feb. 1984 Feb. 86 Feb. 88 Feb. 90 Feb. 92 Feb. 94 Feb. 96 Feb. 98 Aug. 99 Aug. 2000 Aug. 01 02/Q2 02/Q4 03/Q2 03/Q4 04/Q2 04/Q4 05/Q2 05/Q4 06/Q2 06/Q4 07/Q2 07/Q4 08/Q2 08/Q4 09/Q2 09/Q4 10/Q2 10/Q4 11/Q2 11/Q4 12/Q2 12/Q4 13/Q2 13/Q4 14/Q2 14/Q4 15/Q2 15/Q4 16/Q2 16/Q4 17/Q2 17/Q4 18/Q2 18/Q4 Number of regular employees (both sexes, aged 65 years and over) Number of non-regular employees (both sexes, aged 65 years and over) Number of regular employees (female) Number of non-regular employees (female) Rate of non-regular employees (female, right scale) Rate of non-regular employees (both sexes, aged 65 years and over, right scale) Rate of non-regular employees (both sexes, aged 15-64 years, right scale) Note: Regular employees and non-regular employees exclude executives of companies and corporations. The figures for "Before QQE" and "After QQE" show the annualized growth rates of employees from 2008/Q1 to 2013/Q1 and those from 2013/Q1 to 2018/Q4, respectively. Source: Ministry of Internal Affairs and Communications, "Labour Force Survey." Moreover, Chart 2 also shows that employment of the elderly has been growing. However, in the case of the elderly, the share of non-regular employees has been rising. The reason is likely that many are hired as temporary or part-time workers after reaching retirement age. For details, see Ministry of Health, Labour and Welfare, FY2017 Basic Survey of Gender Equality in Employment Management (available only in Japanese), July 2018. Because Japan's population is aging, this means that it is unlikely that the share of non-regular employees in employment as a whole will decrease. However, looking at employees between 15 and 64 years of age, the share of non-regular employees has been declining since around 2014. While it is difficult for the elderly to obtain regular employment, the fact is that more and more are gaining the opportunity to work. In September 2017, the government launched the "Council for Designing a 100-Year Life Society," and in June 2018 it released the report "[B]asic [D]esign for the Human Resources Development Revolution," calling for increased employment of the elderly.3 At the same time, however, the proliferation of the notion of a "100-Year Life" may have made people aware of the longevity risk again, which may have led to the rise in the savings rate, or in other words, the decline in the consumption rate, which I will talk about later. Decrease in Suicides When unable to find a job in the face of a difficult employment situation, being under such stress causes one to question their worth to society. Indeed, studies show that suicides increase in tandem with a rise in the number of unemployed.4 Assuming that this is true, suicides should decrease if the unemployment rate were to decline. Chart 3, which shows the number of suicides and the unemployment rate, indicates that the two are linked: as the unemployment rate rises, the number of suicides increases, and vice versa. While I do not think that suicides are caused by economic problems alone, what is clear is that the number of suicides per year has fallen by 7,000 or more since 2012 as a result of the upturn in the economy and the decline in the unemployment rate. At the G-20 Symposium "For a Better Future: Demographic Changes and Macroeconomic Challenges" held in January 2019, seven out of 13 speakers stressed the importance of labor force participation by the elderly in overcoming demographic challenges posed by the aging population. 4 See, for example, Yasuyuki Sawada, Michiko Ueda, and Tetsuya Matsubayashi, Economic Analysis of Suicide Prevention Towards Evidence-Based Policy-Making, Singapore: Springer, 2017. Chart 3 Unemployment Rate and Suicides 40,000 persons % 35,000 30,000 25,000 20,000 15,000 10,000 5,000 1980 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Number of suicides Unemployment rate (right scale) Sources: National Police Agency, "Suicide Statistics"; Ministry of Internal Affairs and Communications, "Labour Force Survey." Slight Increase in the Birth Rate I think that a small improvement in the birth rate also has been achieved. Chart 4 shows the unemployment rate, the marriage rate, and the birth rate for the population of 20- to 39-year-olds. It is a well-known fact that the marriage rate and the birth rate are correlated, as is more or less evident from the chart. Chart 4 Rates of Unemployment, Marriage, and Birth 100 thous. persons (live births); persons (birth rate); cases (marriage rate) % 1968 71 80 83 86 89 92 95 98 01 04 07 10 13 16 Number of live births Birth rate (per 1,000 population aged 20 to 39) Marriage rate (per 1,000 population aged 20 to 39) Unemployment rate (aged 20 to 39, right scale) Note: For 1975 onward, the birth rate is calculated as the number of live births to mothers aged 20 to 39 divided by the population aged 20 to 39. For 1974 and earlier, the birth rate is calculated as the total number of live births divided by the population aged 20 to 39. The marriage rate is calculated as the total number of marriages divided by the population aged 20 to 39. Sources: Ministry of Internal Affairs and Communications, "Labour Force Survey"; Ministry of Health, Labour and Welfare, "Vital Statistics." Let us take a closer look at this. The birth rate per 1,000 population aged 20 to 39 (hereafter birth rate), which previously had been on a declining trend, has been rising since 2005 along with the decline in the unemployment rate. The bar graph in the chart illustrates this trend in terms of live births per population (hereafter live births). Note how, when comparing two age groups with the same birth rate, the number of live births increases for the age group with a greater number of constituents. Given that second-generation baby boomers (children of baby boomers born between 1947 and 1949) reached their average marriage age sometime between 1995 and 2000 or, if we take the rise in the average marriage age into account, sometime between 2000 and 2005, the number of live births subsequently would have increased had there been a reversal in the birth rate around this time. There turned out to be no such increase, however. The reason is that, during the approximate period from 1995 to 2005 and in the few years after the outbreak of the global financial crisis in 2008, young people of this generation were not able to find stable employment due to the so-called employment ice age, which led them to think twice about marriage and having children. 5 , 6 Put differently, had QQE been introduced at an earlier stage, second-generation baby boomers would not have had to cope with the repercussions of the employment ice age, likely resulting in an increase in the number of live births from around 1995. Improvement in Government Finances An improvement in employment means that incomes increase. Firms hire people because their profits are rising. When employment grows, both profits and wages increase. When there is an increase in profits and wages -- that is, the income of the country as a whole -the government's tax revenue also rises. Chart 5 shows the general government fiscal balance (relative to GDP) and government debt (also relative to GDP). While Japan's fiscal situation is severe, its deficit in fiscal 2017 shrank to 2.7 percent of GDP. Compared with a deficit of 8.3 percent in fiscal 2012, this is an improvement of about 5.5 percentage points. The reason is that the economy has been doing well and the government's tax revenue has been increasing. The increase in tax revenue due to the consumption tax hike from 5 to 8 percent is said to amount to about 8 trillion yen (1.5 percent of GDP). While the remaining improvement of 4.0 percentage points is partly attributable to the effects of a positive turnaround in overseas economies, it owes in large part to the improvement in the economy For details on the employment ice age, see Genda Yuji et. al, Shūshoku hyōgaki sedai no keizai shakai e no eikyō to taisaku ni kansuru kenkyū iinkai hōkokusho, Research Institute for Advancement of Living Standards, November 2016. 6 In his recent book, former Bank of Japan Governor Shirakawa argues that the immediate response of many major Japanese firms to the large demand shock brought about by the bursting of the bubble and the outbreak of the global financial crisis in 2008 was to reduce graduate recruitment and increase non-regular employment. During this so-called employment ice age, the young bore the brunt of the employment adjustment. University graduates entering the labor market during this time -- the so-called second-generation baby boomers -- found it difficult to accumulate sufficient skills as young workers, leading to lower income levels, which in turn has had a lasting social impact including an increase in the rate of those who are unmarried and the consequent decrease in the number of births (available only in Japanese). Shirakawa Masaaki, Chūō Ginkō (Tokyo: Toyo Keizai, 2018), p. 112. as a result of QQE. Moreover, the ratio of government debt to GDP also has declined slightly from its peak of 239 percent in fiscal 2015. Chart 5 Fiscal Balance and Debt of General Government Relative to Nominal GDP % % -2 -4 -6 -8 -10 -12 FY 1994 Fiscal balance Government debt outstanding (right scale) Source: Cabinet Office, "System of National Accounts." Decline in Personal Income Inequality Furthermore, income inequality has declined. Results of statistics show that income inequality in terms of equivalized disposable income has declined.7,8 Meanwhile, Chart 6 See Statistics Bureau, Ministry of Internal Affairs and Communications, "Analytical [Results of] Income Distribution," 2014 National Survey of Family Income and Expenditure (available only in Japanese), October 2016. 8 Equivalized disposable income is obtained by adjusting the quotient of household disposable income and the square root of the number of household members. In its international comparisons, the Organisation for Economic Co-operation and Development (OECD) uses the Gini coefficient (see footnote 11) and the relative poverty rate for each country calculated on the basis of equivalized disposable income. shows the trend in the relative poverty rate.9 As the chart shows, the relative poverty rate has declined, regardless of whether we look at the overall rate, the child poverty rate, or the poverty rate of single-parent households. Since most single-parent households are single-mother households, the chart indicates that the poverty rate of single mothers has declined from 62.0 percent in 2009 to 47.7 percent in 2014. While it is shocking that the poverty rate for single mothers is close to 50 percent, I view the rate's decline to this extent as a substantial achievement.10 Chart 6 Relative Poverty Rate % % Overall Children Single-parent households Sources: Ministry of Internal Affairs and Communications, "2014 National Survey of Family Income and Expenditure." The relative poverty rate of a country is the proportion of its household members whose equivalized disposable income falls below the poverty line (one-half the median equivalized disposable income). Inequality has fallen from 2009 to 2014 in terms of the Gini coefficient for equivalized disposable income. For details, see 2014 National Survey of Family Income and Expenditure (available only in Japanese). 10 Similarly, the relative poverty rate, the child poverty rate, and the poverty rate of single working-age households with at least one child have all declined from 2012 to 2015. See Ministry of Health, Labour and Welfare, Summary Report of Comprehensive Survey of Living Conditions 2016, June 2017. Decline in Regional Income Inequality Regional income inequality also has been declining. The left panel of Chart 7 shows the ratio of the average per capita prefectural income of the top five prefectures weighted by population to that of the bottom five prefectures weighted by population (top five prefectures divided by bottom five prefectures) and the Gini coefficient of prefectural income.11 The chart seems to exhibit that, after dipping in fiscal 2010 following the outbreak of the global financial crisis in 2008 (reflecting the decrease in income in wealthier regions), inequality increased again; however, compared to fiscal 2012, the year before the introduction of QQE, inequality appears to have decreased. In other words, regional income inequality is falling. Moreover, as seen in the right panel of Chart 7, income both in the top five and the bottom five prefectures is growing, which is why it cannot be said that inequality has been falling because the top prefectures other than Tokyo -- with the highest income level in Japan -- have become poorer. While I would not go so far as to say that the decline in inequality is due solely to QQE, I think it can be said that the decline is due to the benefits of the economic expansion extending to all regions. However, it also is argued that the decline in regional inequality is not necessarily something to celebrate. The reasoning for this is that Tokyo has fallen behind in the competition among major global cities, as evidenced by the fact that the average per capita income in Tokyo today is still lower than in fiscal 2007. The Gini coefficient represents the degree of concentration in the distribution of income, etc., and is an indicator to measure inequality. The closer the coefficient is to zero, the smaller the extent of inequality, and the closer it is to one, the greater the extent. Here, the Gini coefficient is calculated on the basis of population-weighted per capita prefectural incomes. Chart 7 Regional Income Inequality Measured by Per Capita Prefectural Income 0.15 6,000 thousand yen 5,500 0.14 0.13 0.12 5,000 4,500 4,000 3,500 3,000 0.11 2,500 2,000 0.10 FY 2006 1,500 FY 2006 Ranked highest Ranked 3rd highest Ranked 5th highest Ranked 4th lowest Ranked 2nd lowest Gini coefficient Top 5 prefectures / bottom 5 prefectures (right scale) Ranked 2nd highest Ranked 4th highest Ranked 5th lowest Ranked 3rd lowest Ranked lowest Source: Cabinet Office, "System of Prefectural Accounts." Japan, a More Open Country Today Lastly, with the economy continuing to grow, Japan appears to be becoming more interested in and open to foreign cultures, people, services, and products. Amid growing anti-free trade sentiments in many advanced economies, Japan concluded the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP, which came into effect in December 2018) and the Japan-EU Economic Partnership Agreement (EPA, which came into effect in February 2019). Japan is now a global standard bearer of free trade. Moreover, with the amendment to the Immigration Control and Refugee Recognition Act in December 2018, Japan is seeking to attract overseas workers and improve their employment conditions. II. Recent Economic Developments In my description of the achievements of monetary policy, I have focused so far on developments other than short-term economic indicators. I would now like to talk about recent economic developments. Charts 8 and 9 provide an overview of key economic indicators. Almost all the indicators in Chart 8 -- for production, investment, and exports -- have been improving. Some of these were sluggish following the consumption tax hike in April 2014 and thereafter, particularly in the period from the second half of 2014 to the first half of 2016, when global trade volume was sluggish. However, there also are some indicators that are falling currently. I will elaborate on this later. Chart 8 Production, Investment, Exports, and World Trade Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 s.a., CY 2012 = 100 Introduction of QQE with Yield Curve Control Sep. 2016 └ └ └ └ Industrial production Aggregate supply of capital goods └ └ └ World trade volume Real exports Sources: Ministry of Economy, Trade and Industry, "Indices of Industrial Production," "Indices of Industrial Domestic Shipments and Imports"; CPB Netherlands Bureau for Economic Policy Analysis, "CPB World Trade Monitor"; Bank of Japan, "Developments in Real Exports and Real Imports." └ 19 Chart 9 looks at wages, employment, employee income, which is obtained by multiplying wages by the number of employees, and consumption.12 The reason why real wages per worker have not increased is that the number of non-regular workers working short hours has increased. On the other hand, real employee income was sluggish only in fiscal 2014, the year of the consumption tax hike; apart from that, it has grown more or less steadily. The unemployment rate also has steadily declined. Chart 9 Employment, Income, and Consumption Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 s.a., CY 2012 = 100 Introduction of QQE with Yield Curve Control Sep. 2016 % 5.0 4.5 4.0 3.5 3.0 2.5 2.0 └ └ └ └ └ └ 19 Number of employees Consumption activity index (travel balance adjusted, real) Real wages Real employee income Consumption rate (real consumption divided by real employee income) Unemployment rate (right scale) Note: Real employee income is calculated as the number of employees multiplied by real wages, which is total cash earnings deflated by the CPI (all items less imputed rent). The consumption rate is calculated as the consumption activity index (travel balance adjusted, real) divided by real employee income. Sources: Ministry of Health, Labour and Welfare, "Monthly Labour Survey"; Ministry of Internal Affairs and Communications, "Consumer Price Index," "Labour Force Survey"; Bank of Japan, "Consumption Activity Index." └ └ In my past speeches, I defined real employee income as the number of regular employees multiplied by real wages based on the Monthly Labour Survey. However, taking into account the difference in the level of the number of regular employees for January 2018, I have redefined real employee income as the product of the number of employed based on the Labour Force Survey and real wages based on the Monthly Labour Survey. Among the different indicators, the one showing the weakest improvement is real consumption. Consumption as measured by the consumption activity index is still below the level in 2013; that is, before the spike in demand due to the frontloading of purchases prior to the consumption tax hike. This is a bit strange given that real employee income, on which consumption expenditure rests, has been on a steady upward trend and exceeds the 2013 level, albeit with greater fluctuation since the start of 2018. One of the reasons that the consumption rate (consumption divided by employee income) as defined here has been falling is that disposable income has not increased as much as employee income due to the consecutive annual 0.354 percentage point increases in employee pension insurance premiums. However, because insurance premiums were not raised from 18.3 percent in September 2018 and will not rise any further, this should lead to a rise in the consumption rate in the future. Since it is difficult to imagine that the consumption rate will continue to fall forever, I think that consumption can be expected to recover. As mentioned earlier, the economy has been recovering due to QQE. However, there is concern about the risk of a deterioration in economic activity going forward due to the fall in stock prices since the end of 2018. Often, a decline in stock prices is seen as a harbinger of a future decline in economic activity. While this is the case, stock markets frequently seem to overreact to such risks, and whether this leads to deterioration in economic activity warrants careful monitoring. Given the risks to economic activity going forward, there certainly are a number of issues to consider, such as the conduct of economic policy in the United States, trade friction between the United States and China, the United Kingdom's exit from the European Union (EU), developments in the European economy, and the slowdown of the Chinese economy. Among these, I would like to take a closer look at the Chinese economy. While trends in the Chinese economy are often discussed in terms of real GDP, the decline in the growth rate appears neat -- having been level or declining by 0.1 percentage point every quarter -- and thus there are doubts as to whether GDP figures are an accurate representation of developments in economic activity. Chart 10 shows the level of China's real GDP (quarterly) and import quantity as well as Japan's industrial production and exports. Keeping in mind that GDP and imports correlate with each other in general, while the chart shows that there is no such correlation in the case of China, Japan's production and exports are linked with China's import quantity. This means that, if China's import quantity were to decrease further, this would be cause for concern regarding the outlook for Japan's production and exports. Chart 10 Correlation of Economic Activity between China and Japan Inauguration Introduction Consumption Expansion Introduction of Introduction of of the second of QQE tax hike of QQE QQE with a Negative QQE with Yield Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Curve Control Dec. 2012 Jan. 2016 Sep. 2016 s.a., CY 2012 = 100 └ └ Industrial production (Japan) └ └ Import quantity (China) └ └ Real GDP (China) └ └ 19 Real exports (Japan) Sources: Ministry of Economy, Trade and Industry, "Indices of Industrial Production"; Bank of Japan, "Developments in Real Exports and Real Imports"; National Bureau of Statistics of China, "National Accounts"; Haver Analytics. If the risks I explained earlier were to materialize, I think it would be necessary to implement additional monetary easing without delay through quantitative, qualitative, and interest rate policy measures. Meanwhile, until last year, there had been debate on financial imbalances and a potential bubble. However, because stock prices have dropped substantially since then, it would be rather unreasonable to argue that there are financial imbalances in the stock market now. III. The Bank's Monetary Easing Policy and the Profitability of Private Banks While QQE has led to the long-term, structural, and short-term improvements in the economy that I have described, it also has been argued that a prolonged period of monetary easing has undermined the profitability of financial institutions. I would like to explain my views on this.13 First of all, since bold monetary easing has produced favorable results for Japan's economy as a whole, I feel that it is a bit curious that the same cannot be said about financial institutions. Chart 11 shows nominal GDP of the financial and insurance industry (hereafter, financial industry) and the manufacturing industry, as well as overall nominal GDP of Japan and the United States. The chart shows that, whereas in the United States, the financial industry's GDP has been growing along with the growth in overall nominal GDP, in Japan, the financial industry's GDP has been particularly stagnant amid the sluggishness of nominal GDP overall. Next, let us look at how nominal GDP has recovered since 2009, the trough following the outbreak of the global financial crisis in September 2008. Following the drop in 2009, Japan's nominal GDP stagnated until 2012 but then recovered from 2013, when QQE was introduced. While nominal GDP of the manufacturing industry has been recovering along with the recovery in overall nominal GDP, that of the financial industry does not appear to have recovered. However, as shown in the table underneath the chart, the financial industry's GDP, which had been decreasing at an annual rate of 2.5 percent until 2012, stopped contracting following the introduction of QQE. This shows that, if nominal GDP grows, the financial industry's GDP also is likely to grow. What is described hereafter owes in large part to Harada Yutaka, "Kin'yū kanwa seisaku no kōka wa kin'yū kikan ni mo todoku," Shūkan Kin'yū Zaisei Jijyō, October 8, 2018. Chart 11 Nominal GDP of the Financial Industry: Comparison between Japan and the United States U. S. Japan tril. yen tril. yen 300 25 1994 97 tril. U.S. dollars tril. U.S. dollars 1994 97 00 03 06 09 12 15 Nominal GDP Manufacturing (right scale) Finance and insurance (right scale) 00 03 06 09 12 15 Nominal GDP Manufacturing (right scale) Finance and insurance (right scale) Average Annual Growth Rate of Nominal GDP after the Global Financial Crisis (%) Japan United States 2009-12 2012-17 2009-12 2012-17 Nominal GDP 0.4 1.9 3.9 3.8 Manufacturing 1.4 3.0 4.2 2.5 Finance and insurance -2.5 0.1 6.4 4.7 Sources: Cabinet Office, "System of National Accounts"; U.S. Bureau of Economic Analysis. Turning to nominal GDP figures for the United States in Chart 11, overall nominal GDP has continued to grow after the global financial crisis and, in line with that, nominal GDP figures for the manufacturing and financial industries also have been growing. Furthermore, there is no change in the growth trend after 2012 like the one seen in Japan's case. This is because the Federal Reserve conducted bold monetary easing immediately following the global financial crisis. Meanwhile, while the fact that the growth rate of the financial industry exceeds that of overall nominal GDP likely reflects the entrepreneurial spirit of the U.S. financial industry, if nominal GDP had not grown in the first place, I think that the growth rate of the financial industry also would have been lower. The bold monetary easing policy, which aims at achieving the price stability target of 2 percent, has led to an improvement in employment, a rise in wages, and an increase in corporate profits, as seen in the rise in stock prices. Since nominal GDP is the sum of all wages and profits, an increase in wages and profits naturally means that nominal GDP also increases. If nominal GDP increases, banks' nominal GDP also can be expected to increase. Moreover, the business conditions of firms borrowing money from banks also should improve, so that among them would be firms that want to borrow more. Credit costs also have declined as a result. Monetary Easing Is Creating Demand for Loans Chart 12 shows the loans and deposits of domestic banks. Starting with loans, these followed a declining trend after the collapse of the bubble economy. While in the wake of the introduction of quantitative easing (QE) in 2001 it took a while for loans to start increasing, they soon started to do so after the introduction of QQE. While loans have increased by 74 trillion yen from March 2013 to December 2018, deposits have increased by as much as 147 trillion yen. For banks, deposits can be regarded as their "products" and loans as their "sales." The difference between "sales" and "products" represents "inventory." An increase in deposits in excess of the increase in loans thus is equivalent to an increase in inventories. What is needed, then, is a reduction in inventories. The fundamental reason for financial institutions' difficulties is that they are accumulating funds but there are no borrowers. Chart 12 Loans and Deposits of Private Banks in Japan Introduction of QQE tril. yen 1983 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Loans and bills discounted Deposits Note: Domestically licensed banks are banks established under Japanese legislation. Figures exclude those for Japan Post Bank. Source: Bank of Japan, "Financial Institutions Accounts." Policy Tightening Does Not Guarantee a Steepening of the Yield Curve A decline in interest rates brought about by bold monetary easing results in a deterioration in private banks' profitability -- this most likely is the case because of the assumption held by many in the financial communities that the yield curve will steepen, the term spread will increase, and hence the loan interest rates will increase when the Bank raises interest rates. Given that private banks borrow short-term debt and finance longer-term lending, their profits grow if the term spread increases. This is not to say, however, that the term spread increases with every rise in the interest rate.14 Whether the yield curve flattens or steepens when short-term interest rates are raised depends on the economic situation as well as the market's view of monetary policy at the time. Therefore, it is not necessarily the case that the yield curve will steepen if short-term interest rates are raised. Regarding details of the relationship between policy changes and the yield curve, see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Ishikawa," Bank of Japan, July 2018. If Prices Decline, So Will Interest Rates If prices decline, so will nominal interest rates. Given that the real growth rate normally declines under such circumstances, so does nominal GDP, or the product of prices and real production. A decline in nominal GDP represents economic deterioration. This means that credit costs -- costs resulting from bankruptcies of borrowing firms -- will rise, demand for loans will decrease, and ultimately interest rates will decline.15 One factor that has a significant impact on financial institutions' profitability is the fact that many people today have a sufficient amount of cash and deposits, which has naturally caused the number of borrowers to decrease. Another is credit costs -- in other words, the devaluation costs of impaired assets. Sales growth for borrowing firms is expected to be weak without nominal GDP growth, and their loans could very well turn into nonperforming ones. Following the introduction of QQE, the nominal GDP growth rate, which had been negative since the global financial crisis, has turned positive. Looking back, Japan's nominal GDP, which had posted more or less negative growth since 1998, resumed positive growth from 2004 as the economy enjoyed the effects of QE introduced in 2001. The significant economic downturn that began in 2008 is attributable to the global financial crisis and not necessarily due to the Bank's decision to discontinue QE, although I must admit that there should have been a better time to cease monetary easing than before the storm. Barring the implementation of both QE and QQE, Japan's nominal GDP growth would have remained in negative territory this whole time since 1998. To make an educated guess, financial institutions' profitability could have deteriorated much further than it actually did. When private banks call for interest rate rises, this is an indication of their belief that the yield curve will steepen and the term spread will increase with a rise in interest rates. However, as I have explained, the facts prove that a rise in interest rates does not guarantee a steepening of the yield curve. Moreover, if monetary easing is discontinued, prices will decline, the economy will deteriorate, and nominal interest rates will decline. Financial For more on this point, see Harada Yutaka, "Naze nihon no kinri wa hikui no ka," Keiki to saikuru, no. 62, Japan Association of Business Cycle Studies, November 2016. institutions seem to expect that, in the case of a rise in interest rates, only the rates on investment will increase without any changes in foreign exchange rates as well as prices of stocks and bonds, or a decline in firms' willingness to borrow. I am afraid this is not realistic. Rather, premature policy tightening in the past caused economic deterioration, a decline in both prices and production, and lowered interest rates in the long run. It can be said to have played a role in creating the challenges faced by the financial industry today. IV. The Economic Outlook and the Price Stability Target of 2 Percent I mentioned earlier that the economy currently may be weak, and the same can be said about prices. Even so, if the economy continues to recover, the labor market will tighten and prices eventually will rise. There are some hurdles to overcome in achieving stable price rises, however. First is the difficult situation the economy currently faces, as you are already familiar with. Looking back at Japan's past trends, the economy often would enter a recession when the sluggishness of the global economy held back exports, leading to a decline in business fixed investment and consumption. While a typical example of this is the recession following the outbreak of the global financial crisis in 2008, the stagnation in Japan's economy from the latter half of 2015 also can be said to have been affected significantly by the sluggishness of the global economy, especially China. Second is consumption tax hikes. Tax hikes could push the economy into recession, and a resultant decrease in demand could push down prices. Regarding the hike scheduled to take place in October 2019, its effects are likely to be smaller than those of the previous hike in April 2014 due to the following reasons: the rate increase -- from 8 percent to 10 percent -is smaller than that of the previous hike; a reduced tax rate will be applied to some items; permanent measures such as those concerning the provision of free education will be implemented; and a variety of measures are to be taken so as to smooth out the effects of the front-loaded increase in demand and its fallback. However, the effects of the previous tax hike, which many economists expected to be limited, have proved significant and lasting.16 A decline in demand, such as the one seen after the previous hike, naturally would contain inflation. Third is price declines associated with the scheduled consumption tax hike. Measures concerning the provision of free education will be implemented alongside the hike. The Bank estimates that the measures' effects on the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food will amount to minus 0.3 percentage point for fiscal 2019 and minus 0.4 percentage point for fiscal 2020. Meanwhile, the Bank estimates that the hike will push up the year-on-year rate of change in the CPI for all items less fresh food for fiscal 2019 and 2020, each by 0.5 percentage point. The upcoming tax hike is thus a key factor affecting prices. As it is evident that consumption tax hikes exert both positive and negative effects on the CPI, these effects should be taken into account when speaking in this context. Another factor -- although not directly related to the consumption tax hike -- is a reduction in mobile phone-related prices. At the moment, a precise figure cannot be given as to how large its impact will be, but an estimation by private economists shows that the reduction will push down the year-on-year rate of change in the CPI for all items less fresh food by 0.5 to 1.0 percentage point.17 Assuming that this estimation is correct, achievement of the 2 percent price stability target inevitably would be delayed. Regardless of these setbacks, I am not too pessimistic. These are no different from tax cuts, and people's real income increases by an amount equivalent to the degree of price declines. Hypothetically, at times when everyone feels that the economy has been booming, extra money arising from the provision of free education and a reduction in mobile phone-related prices would be spent immediately, which would lead to inflation through a demand increase, whereas in today's economy, it likely will take time for demand to increase. Extra See Miyazaki Hiroshi, "Shōhi zeiritsu hikiage no eikyō ga yosougai ni ōkikatta no wa naze ka," chap. 6 in Abenomikusu no shinka, ed. Harada Yutaka and Masujima Minoru (Tokyo: Chuokeizai-sha, 2018). 17 For more on this estimation, see Kobayashi Shunsuke and Yamaguchi Akane, "2018-nen jyūgatsu zenkoku shōhisha bukka," Daiwa Institute of Research, November 2018, https://www.dir.co.jp/report/research/economics/japan/20181122_020468.html. money will not disappear into thin air, however. These factors are capable of delaying the achievement of the price stability target but do not hamper the achievement itself. This also could be said about other price declines, including those in crude oil prices. Nevertheless, there is a risk that the current sluggishness in observed prices will spill over to inflation expectations, further delaying inflation. My Thinking on the Bank's Policy Change on July 31, 2018 Lastly, I would like to explain my views regarding the Bank's policy change in 2018. At the Monetary Policy Meeting held on July 31, 2018, with a view to strengthening the framework for continuous powerful monetary easing, the Bank (1) introduced forward guidance for policy rates, stating that "the Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019" and (2) decided that, under yield curve control, "the [10-year JGB] yields may move upward and downward to some extent mainly depending on developments in economic activity and prices." With regard to long-term yield movements, Governor Kuroda stated in the press conference given after the Monetary Policy Meeting that the Bank would conduct monetary policy while bearing in mind that the yields might move upward and downward at about double the range observed until then of around plus or minus 0.1 percent. I opposed the proposal for this policy change for the following reasons. First, as for forward guidance, I considered that this should not be related to timing but rather to economic indicators in such a way that it further clarified its relationship with the price stability target. In other words, it was my view that the conduct of monetary policy should be data-dependent, not calendar-based. From this viewpoint, regarding the expression "for an extended period of time," I viewed it as appropriate to add such phrases as "unless prices show stronger movements than currently anticipated." Let me note that, at the time, there was strong anticipation in the market of an early interest rate hike regardless of the consumption tax hike scheduled in October 2019. I therefore thought that it was reasonable to convey the message that such an early interest rate hike was not possible. To take a step further and strengthen this message, and to respond flexibly when there are changes in economic developments, I considered, as just mentioned, that it should be emphasized that the forward guidance ought to be data-dependent. This is based on the thinking that, if the economy deteriorates more than anticipated, additional easing measures will be necessary while, on the contrary, if it improves, it will be necessary to weaken monetary easing. Second, I also opposed allowing the long-term yields to move in a more flexible manner; namely, because it was too ambiguous as the guideline for market operations. Prior to the policy change, the guideline that the Bank will purchase JGBs so that the long-term yields will remain at around 0 percent meant that, if the economy improved further, the Bank would increase its JGB purchases to maintain the yields at around 0 percent and thereby strengthen the monetary easing effects. Given this, announcing at this point that "the yields may move upward and downward to some extent" would in fact weaken such effects. Concluding Remarks I have reviewed the achievements of the Bank's QQE introduced in 2013. First, I talked about its long-term effects, centering on the improvement in employment. Women and the elderly have made advances in society, Japan's fiscal situation has improved in the long run, and it is expected that the number of suicides will decline and the birth rate will rise. I also noted that such improvement in the economic situation is accompanied by a decline in income inequality. Second, I explained that short-term economic indicators have been improving continuously. However, consumption has been weak relative to the increase in income, and downside risks to the economy have been increasing since the end of 2018. Third, I pointed out the relationship between QQE and the profitability of private banks. What I think is strange is that, in the eyes of bank managers at least, although Japan's economy as a whole has been improving due to QQE, the positive effects of QQE have not been felt among financial institutions. Fourth, I described the economic outlook and the price stability target of 2 percent. In addition to the consumption tax hike, measures concerning the provision of free education are to be implemented, the latter of which will directly cause a decline in prices. Nonetheless, I am not too pessimistic because, while the hike is in itself a tax increase, measures concerning the provision of free education are no different from tax cuts. In relation to economic activity, tax increases are a cause for concern but tax cuts produce positive effects. However, if the economy deteriorates to the extent that achieving the 2 percent price stability target in the long term becomes difficult, I view it as necessary to strengthen monetary easing without delay. Thank you for your attention.
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Speech by Mr Hitoshi Suzuki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ibaraki, 28 February 2019.
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Speech by Mr Goushi Kataoka, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kagawa, 27 February 2019.
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February 27, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kagawa Goushi Kataoka Member of the Policy Board (English translation based on the Japanese original) I. Economic Activity and Prices A. Overseas Economies I would like to start my speech by looking at developments in overseas economies. After the global economy had grown synchronously since the second half of 2016, differences in growth rates among countries have recently become evident. I consider that overseas economies have now leveled off and are in a state where due attention should be paid to the effects of various risks. According to the January 2019 World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF), as presented in Chart 1, the global economic growth rate is projected to remain around 3.5 percent through 2020. However, when compared with the April 2018 WEO forecast, downward revisions are evident, as seen on the right-hand side in Chart 1. In addition, the global Purchasing Managers' Index (PMI), as shown in Chart 2, has declined to a level seen during the global economic destabilization in 2016 for both manufacturing and services, although they are still above the 50-point level. Thus, the pace of overseas economic growth as a whole for 2019 seems to have weakened compared with that for 2018. Let me elaborate on current developments by major countries and regions. With regard to the U.S. economy, interest rate-sensitive housing investment has been weak and some soft data have been showing signs of peaking out against the background of a rise in U.S. interest rates, while growth in exports has been decelerating. Nevertheless, private consumption has been supported by tax cuts and a favorable employment situation. As for the European economy, its pace of growth has been decelerating, partly due to the effects of a tightening of European Union (EU) emission standards and the political situations in Italy and France, although domestic demand has been more or less firm. As with the European economy, the Chinese economy has been decelerating, and the impact of this deceleration on emerging economies is a matter of concern. The following factors continue to pose a risk to the outlook: U.S. macroeconomic policies and the consequences of protectionist moves, the impact these have on the global economy and financial markets, and negotiations on the United Kingdom's exit from the EU. Future developments require close attention as the effects of these risks have already been seen in some economies. B. Japan's Economy Next, I would like to turn to Japan's economy. Starting with recent developments, the real GDP growth rate for the October-December quarter of 2018 recovered to positive territory after a decline in the previous quarter. This was partly due to the rebound from the decrease in domestic demand caused mainly by natural disasters in the July-September quarter. However, the recovery from negative growth is losing momentum amid heightening uncertainties regarding overseas economies. Chart 3 shows the real GDP growth rate and the breakdown by component. While private consumption and private business fixed investment picked up, the contribution of external demand further decreased within negative territory compared with that for the July-September quarter, partly due to an increase in imports. Although exports increased after a decline in the previous quarter, the overall rate of increase remained relatively low given a drop due to the effects of supply-side constraints caused by natural disasters.1 The low rate of increase in exports is attributable mainly to a decrease in orders from China against the background of U.S.-China trade friction and a gradual deceleration in overseas economies. Turning to the outlook for Japan's economy, as shown in Chart 4, the medians of forecasts made by the Bank of Japan's Policy Board members for real GDP growth rates presented in the January 2019 Outlook for Economic Activity and Prices (Outlook Report) are 0.9 percent for both fiscal 2018 and 2019, and 1.0 percent for fiscal 2020. My view, however, is that the pace of growth will be more modest than these forecasts. Specifically, I would project the growth rate for fiscal 2018 to be around 0.5 percent, as the pace of economic recovery will likely remain moderate amid the heightening uncertainties regarding overseas economies. For both fiscal 2019 and 2020, the growth rate will likely be in the range of 0.5-1.0 percent. The impact on households of the consumption tax hike scheduled to take place in October 2019 will likely be smaller than that of the previous hike in 2014, as the government will take Attention should also be paid to the fact that real GDP growth rates on an annualized quarter-onquarter basis have been on a declining trend since the January-March quarter of 2018, and that the rate for the October-December quarter fell for the first time since the October-December quarter of 2014, which followed the consumption tax hike in April that year. measures to smooth out possible fluctuations in demand. Nevertheless, it is a matter of concern that the pace of expansion in consumption since fiscal 2014 has been quite slow and households' sentiment indicators such as the Consumer Confidence Index have continued to decline since 2018 (Chart 5). 2 Moreover, I consider that the pace of pick-up in Japan's economy will likely be slow from the scheduled consumption tax hike in October onward, mainly because the heightening of uncertainties in the global economy, which I mentioned earlier, might limit business activity to a certain degree through expectations of a slowdown in external demand. C. Recent Developments and Outlook for Prices Next, I will move on to price developments. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food for January 2019 was 0.8 percent, as shown in the left-hand graph of Chart 6. Looking at the CPI in detail, it should be noted that the contribution of a rise in energy prices to the CPI was significant at 0.4 percentage point, and the rate of increase for all items less fresh food and energy, which directly reflects supplydemand conditions, stood at only 0.4 percent year on year. The right-hand graph of Chart 6 shows some indicators that represent the underlying developments in consumer prices. These indicators have continued to show relatively weak developments. The important indicators that affect underlying price developments are the output gap and medium- to long-term inflation expectations. The output gap, as shown in the left-hand graph of Chart 7, has remained positive, reflecting improvements in the capital stock and labor markets. Nevertheless, the positive output gap shrank slightly for the July-September quarter of 2018, mainly due to the effects of natural disasters. Inflation expectations have been somewhat weak, as indicated in the right-hand graph of Chart 7. I am convinced that this is attributable to the adverse effects of prolonged deflation in the past and recent weak price developments. In addition, in my view, the credibility of achieving the Bank's 2 percent price stability target has not been sufficiently enhanced among the public, and this is also affecting inflation expectations. Looking at the Consumer Confidence Index, the decrease in the consumer perception index since 2018 was mainly attributable to a decline in perceptions of "employment" (job stability or ease of finding a job) and "overall livelihood." Turning to the outlook for prices, the medians of the Policy Board members' forecasts for the year-on-year rate of change in the CPI (all items less fresh food) presented in the January 2019 Outlook Report are 0.8 percent for fiscal 2018, 0.9 percent for fiscal 2019, and 1.4 percent for fiscal 2020, excluding the direct effects of the scheduled consumption tax hike and policies concerning the provision of free education (Chart 4).3 Price projections have continued to be revised downward, reflecting the weak price developments, but the Bank's view is that the momentum of prices toward the 2 percent price stability target will be maintained. However, I dissented from the relevant description in the January Outlook Report as I think the possibility of the inflation rate rising toward 2 percent is low at the moment and that the momentum of inflation has not been strengthened. There are four main reasons behind my position. First, under the present circumstances, the effects of a widening of the output gap on inflation might have become less pronounced.4 Second, there is a possibility that the expanding trend of the output gap will not continue. If the expanding trend of the output gap becomes even more robust, firms will likely increase prices and wages to better reflect a rise in costs and a tightening of labor market conditions. These firms' moves will likely progress more than an increase in households' tolerance of price rises. However, taking account of the outlook for Japan's economy, I consider that there is a strong possibility that the expanding trend of the output gap will rather abate going forward.5 Third, based on the first two points, there is little prospect for the time being of an increase in inflation expectations through the adaptive formation mechanism pushing up the observed inflation rate. Fourth, it is unlikely for inflation to be spurred by an increase in inflation expectations on the back of an enhancement If a reduction in charges for mobile phone services takes place, it is expected to put downward pressure on prices in the short term. 4 From the second half of 2016 through 2018, the output gap estimated by the Bank's staff widened from a level of excess supply to excess demand of around 1.5 percent. Meanwhile, the year-on-year rate of change in the CPI for all items less fresh food and energy remained more or less unchanged at around 0.3 percent. 5 As I mentioned in section I. B., the pace of pick-up in Japan's economy will likely be slow from the scheduled consumption tax hike in October 2019 onward, mainly considering the following factors: in a situation where the pace of expansion in consumption since fiscal 2014 has been quite slow, households' sentiment indicators have continued to decline since 2018, and the heightening of uncertainties in the global economy might limit business activity to a certain degree through expectations of a slowdown in external demand. of the credibility of achieving the price stability target. This is because such enhancement is unlikely in a situation where the monetary policy remains unchanged amid downward revisions to the Policy Board members' price projections. II. Conduct of Monetary Policy Let me first outline the Bank's current monetary policy, based on the outlook for economic activity and prices that I have described. I would then like to touch on my opinion about the Bank's monetary policy conduct. The Bank conducts monetary policy under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the 2 percent price stability target. This current framework consists of three major components (Chart 8). The first is yield curve control, in which the Bank sets the short-term policy interest rate at minus 0.1 percent and the operating target for long-term interest rates at around 0 percent. As for long-term interest rates, the Bank purchases Japanese government bonds (JGBs) while allowing some degree of fluctuation in long-term yields, depending mainly on developments in economic activity and prices. The second component is the purchase of risk assets, including exchange-traded funds (ETFs). The Bank purchases ETFs so that their amount outstanding will increase at an annual pace of about 6 trillion yen. With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions. The third component is the Bank's public commitment regarding the future conduct of monetary policy. In July 2018, the Bank introduced forward guidance for short- and longterm interest rates, stating that "[t]he Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." The Bank aims to strengthen market confidence and expectations regarding the sustainability of monetary easing by making a commitment to the levels of future policy interest rates, in addition to the inflationovershooting commitment regarding the monetary base that has been in place since September 2016. Of these three components, I dissented from two: the yield curve control, and the Bank's commitment regarding the future conduct of monetary policy. As presented in the joint statement by the Bank and the government, the Bank's mission is to achieve the price stability target at the earliest possible time. With this in mind, as for the yield curve control, in the current situation where the observed inflation rate is still evidently far from the 2 percent price stability target, I consider it appropriate to strengthen monetary easing in order to encourage further widening of the output gap within positive territory.6 At the same time, I judge that it is necessary to strengthen the Bank's commitment in order to promote a rise in inflation expectations. 7 Moreover, to overcome deflation completely amid heightening uncertainties regarding economic and price developments, I consider it important to influence the expectations and forecasts of market participants and economic entities by implementing the appropriate means to further coordinate fiscal and monetary policy. 8 Furthermore, I have a difference of opinion regarding the Bank's monetary policy conduct of continuing to persist with current monetary easing until the price stability target is achieved. It is necessary to pay due attention to the fact that sustaining the situation where the output gap is in positive territory over a prolonged period under bold monetary easing entails the risk of accelerating business and financial cycles thereafter.9 Due attention is also required Specifically, I consider it necessary to strengthen monetary easing so that yields on JGBs with maturities of 10 years and longer would broadly be lowered further. 7 Specifically, I consider it would be necessary for the Bank to make a commitment to taking additional easing measures if it revised downward its assessment of medium- to long-term inflation expectations. 8 I would argue that the mindset of firms and households in Japan was formed under the prolonged deflationary environment after the mid-1990s, such that it has become rational to assume that economic activity is sustainable without inflation. In a situation where the anchor of inflation expectations has been lost, I believe that to achieve the 2 percent price stability target and maintain the target price level in a stable manner, it is important not only to enhance monetary easing, but also to further strengthen the coordination of fiscal and monetary policy -- that is, a "policy mix." 9 Given that the output gap in Japan was in negative territory for a long period, some would argue that it is necessary to maintain the output gap within positive territory for a long period in order to change to the fact that, if monetary easing is continued for a protracted period, achieving the price stability target would become less clear as uncertainties regarding the outlook for the economy would be prolonged. In addition, the longer monetary easing is continued, the higher the burden on an exit strategy becomes, and the more the side effects of monetary easing accumulate. Therefore, I believe that in considering the possible side effects, the discussion should be centered on finding ways to achieve the price stability target at the earliest possible time in order to prevent monetary easing from continuing for a protracted period. III. Germany's Industrial Policy and Its Implications for Japan10 Let me now take a slightly different approach and talk about Germany's industrial policy. I am assuming many of you have heard the term "Industrie 4.0" in relation to Germany's industrial policy. In my understanding, "Industrie 4.0" is a strategic initiative that aims for the self-optimization of production, not only by improving the efficiency of production processes and the quality of products and making small-batch production of a large variety of products using digital technology, but also by predicting changes in business environment and enhancing the ability of production to adapt to such changes. In other words, "Industrie 4.0" goes beyond the idea of digitizing production processes; it embodies the concept of optimizing production activities using digital technology so that they are able to adapt to environmental changes. "Industrie 4.0" is a national strategic initiative which was set forth by the German federal government in 2011. The federal government continues to play a leading role in implementing the policy. The framework of "Industrie 4.0" in Chart 9 shows the involvement of the government, with ministers of the federal government serving as chairs, and an organizational structure which encourages extensive cooperation across the public, private, and academic sectors, including industrialists, labor unions, and research institutions, as well as within each the structure in which the inflation rate has remained at a low level. In view of the risks I mention, however, I believe that it is best to achieve the price stability target at the earliest possible time, not only by widening the output gap within positive territory, but also by raising inflation expectations through strengthening the Bank's commitment. 10 I would like to express my sincere gratitude here to Mr. Georg K. Löer, President of North RhineWestphalia (NRW) Japan K.K. and Mr. Kurando Ogi, Representative in Japan of the Saxony Economic Development Corporation for their assistance in compiling this section. sector, from the management level to the field level. In other words, the government not only drafts the basis of the strategy and promotes the policy, but a structure has been established in which the government also gathers opinions and concerns from small and medium-sized enterprises in order to spread the effects of the policy to the very end of the value chain. Moreover, a virtuous cycle in which cooperation among the public, private, and academic sectors is strengthened has become possible, partly because ministers of economic affairs in German state government are often highly specialized and researchers at institutions such as universities are very keen to have their findings used in business. In addition to the federal government's "Industrie 4.0," local governments in Germany are active in supporting start-ups as a means to promote industrial development. Knowledge, skills, and funds are all essential throughout the process of starting up a new business: from the early stages of generating business ideas and developing business plans, through raising funds and merchandizing products, until the business can finally stand on its own. In each of these stages, the local government provides considerable support and invests in the new business on its own behalf to actively fulfill its role as a catalyst to encourage investment in newly established enterprises. As indicated in Chart 10, Japan and Germany have common features in that the share of manufacturing in all industries is large, and that the birthrate is declining and the population aging. Although the pace of aging for managers of small and medium-sized enterprises has been more moderate in Germany compared with Japan, smooth business succession and the development of newly established enterprises are important tasks for Germany as well. Another common challenge is that both Japan and Germany need to enhance added value for their domestic manufacturing in order to tackle the intensification of global competition in manufacturing industry caused by the rise of emerging economies. On the other hand, there are also differences between Japan and Germany. One particularly significant difference is that small and medium-sized enterprises in Germany are more active in expanding their businesses overseas and exporting their products than those in Japan. As a result, there are many "hidden champions" in Germany -- that is, enterprises that have global market shares and are leaders in a particular niche business area. Given the declining birthrate and aging population, I believe that there are many lessons Japan can learn from Germany's industrial policy and from its small and medium-sized enterprises. Germany's industrial policy aims to enhance the added value in domestic industries through extensive cooperation across and within the public, private, and academic sectors, and it places importance on supporting innovative enterprises. Small and medium-sized enterprises in Germany seek to expand their businesses overseas on their own in search of new markets unlike those in Japan whose overseas business expansion typically depends on the corporate groups they belong to. Since Japan and Germany share many common features, I believe that they can expand each other's business opportunities by strengthening their cooperation. Thank you for your attention. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kagawa February 27, 2019 Goushi Kataoka Member of the Policy Board of the Bank of Japan Chart 1 World Economic Outlook by the IMF Advanced Economies January 2019 forecasts (y/y % chg.) World Japan United States Euro Area Germany France Emerging Economies United Kingdom China Brazil India Russia Difference from April 2018 forecasts (% pts.) 3.7 0.9 2.9 1.8 1.5 1.5 1.4 6.6 1.3 7.3 1.7 3.5 1.1 2.5 1.6 1.3 1.5 1.5 6.2 2.5 7.5 1.6 3.6 0.5 1.8 1.7 1.6 1.6 1.6 6.2 2.2 7.7 1.7 －0.2 －0.3 0.0 －0.6 －1.0 －0.6 －0.2 0.0 －1.0 －0.1 0.0 －0.4 ＋0.2 －0.2 －0.4 －0.7 －0.5 0.0 －0.2 0.0 －0.3 ＋0.1 －0.2 ＋0.2 －0.1 0.0 ＋0.1 －0.2 ＋0.1 －0.1 0.0 －0.2 ＋0.2 Note: As for the January 2019 forecasts, figures for 2018 are estimates and those for 2019 onward are projections. All of the figures for the April 2018 forecasts are projections. For India, figures are presented on a fiscal year basis. Source: IMF, “World Economic Outlook (January 2019, April 2018).” Chart 2 Global PMI DI, % pts. Global Manufacturing PMI Output Index Global Services PMI Business Activity Index CY 2013 Note: Figures are from the J.P. Morgan Global PMI. Figures above 50 indicate improvement and below 50 show deterioration on a month-on-month basis. Source: IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.) Chart 3 Real GDP Growth and Breakdown by Component ann., q/q % chg. -5 Private consumption Private business fixed investment, etc. Government spending Exports Imports Change in inventories, etc. Real GDP -10 -15 -20 CY 2013 CY Source: Cabinet Office, "Quarterly Estimates of GDP for October-December 2018 (First Preliminary Estimates)." 18 18 Chart 4 Outlook for Economic Activity and Prices (January 2019 Outlook Report) medians of Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) (Reference) Excluding the effects of the consumption tax hike and policies concerning the provision of free education Fiscal 2018 ＋0.9 ＋0.8 Forecasts made in October 2018 ＋1.4 ＋0.9 Fiscal 2019 ＋0.9 ＋1.1 ＋0.9 Forecasts made in October 2018 ＋0.8 ＋1.6 ＋1.4 Fiscal 2020 ＋1.0 ＋1.5 ＋1.4 Forecasts made in October 2018 ＋0.8 ＋1.6 ＋1.5 Note: The direct effect of the consumption tax hike on the CPI for fiscal 2019 and fiscal 2020 is estimated to be 0.5 percentage points for each year. The direct effects of policies concerning the provision of free education on the CPI for fiscal 2019 and fiscal 2020 are estimated to be minus 0.3 percentage points and minus 0.4 percentage points, respectively. Source: Bank of Japan, "Outlook for Economic Activity and Prices (January 2019)." Chart 5 Household Consumption Consumer Confidence Index Consumption Before and After Tax Hikes Apr. 1996 and Apr. 2013 = 100 105.1 s.a. 104.6 103.9 100.0 99.4 improved worsened Tax hike in April 2014 (from 5% to 8%) Tax hike in April 1997 (from 3% to 5%) 96.7 13 FY 1996 14 FY 2013 Note: The latest figures are as of December 2001 and December 2018. Source: Cabinet Office, "Synthetic Consumption Index." 13CY 2013 14 Note: Households of two or more persons. Consumer Confidence Index is composed of four categories: "overall livelihood," "income growth," "employment," and "willingness to buy durable goods." There are discontinuities between March and April 2013, and between September and October 2018, due to changes in the survey method. Source: Cabinet Office, "Consumer Confidence Survey." Chart 6 Consumer Prices Measures of Underlying Inflation Consumer Price Index 2.0 y/y % chg. y/y % chg. % points 1.0 1.5 1.0 0.5 0.5 0.0 0.0 -0.5 -1.0 -0.5 Trimmed mean CPI (all items less fresh food) -1.5 Weighted median CPI (all items less fresh food and energy) Diffusion index (right scale) -2.0 -1.0 CY 201112 12 13 13 14 14 15 15 16 16 17 17 18 18 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications, "Consumer Price Index." -50 CY CY112011 1212 Notes: 1. The latest figures are as of December 2018. 2. The diffusion index is defined as the share of increasing items minus that of decreasing items. The share of increasing/decreasing items is the share of items in the CPI (less fresh food, consumption tax adjusted) whose price increased/decreased from a year earlier. Sources: Bank of Japan, "Measures of Underlying Inflation"; Ministry of Internal Affairs and Communications. Chart 7 Output Gap and Inflation Expectations Output Gap %, % points y/y % chg. 5.07% (1990/4Q) 1.78% (1997/1Q) 2.02% (2007/4Q) 2.0 Synthetic Indicators of Inflation Expectations y/y % chg. Firms, households, and experts (Consensus Forecasts) 1.57% (2018/2Q) Firms, households, and experts (QUICK Survey) Firms, households, and markets (inflation swap rate) 1.5 1.0 -2 0.5 -4 0.0 CY 10 -2 -4 Labor input gap Capital input gap -6 Output gap Reference: CPI (all items less fresh food and energy; right scale) -8 CY 1985 Notes: 1. The data of the output gap in the left-hand graph are the estimates by the Bank's staff as of January 30, 2019. The CPI figures are adjusted for changes in the consumption tax rate. 2. In the right-hand graph, semiannual data from the Consensus Forecasts up through 2014/Q2 are linearly interpolated. Figures for the Bank’s Opinion Survey on General Public’s Views and Behavior exclude inflation expectations by respondents whose annual inflation expectations were ±5% or greater. The output prices DI in the Tankan (Short-Term Economic Survey of Enterprises in Japan) represents the difference between the share of firms that raised prices in the preceding three months and the share of firms that lowered prices. 3. In the right-hand graph, inflation expectations of firms are taken from the Tankan and those of households are taken from the Bank’s Opinion Survey. For experts’ and markets’ inflation expectations, data from the Consensus Forecasts, the QUICK Survey, and the inflation swap rate are used as indicated by their respective lines. Sources: Ministry of Internal Affairs and Communications, ”Consumer Price Index (Japan; 2015-base)”; Consensus Economics Inc., “Consensus Forecasts”; QUICK, "QUICK Monthly Market Survey (Bonds)"; Bloomberg; Bank of Japan. Outline of the Bank's Monetary Policy Chart 8 (1) Yield Curve Control Short-term rate: The Bank will apply minus 0.1 percent to the Policy-Rate Balances. Long-term rate: The Bank will purchase JGBs so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward or downward to some extent mainly depending on developments in economic activity and prices. (2) Asset Purchases The Bank will purchase ETFs and J-REITs so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively. With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions. (3) Commitment Overshooting commitment: The Bank 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. Forward guidance for policy rates: The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019. Structure of "Industrie 4.0" Chart 9 Federal Minister for Economic Affairs and Energy and Federal Minister of Education and Research Technical/practical expertise decision-making Policy guidance, society, multipliers Steering Body Strategy Group Activities on the market Strategy development, technical coordination, and decisionmaking Agenda setting, political Industrial Consortia and Initiatives steering, and multipliers Implementation on the market Members: Federal Ministers, • State Secretaries business representatives, and Members: • Representatives of steering chairs of working groups Test beds Examples of applications body • Representatives of Federal Working Groups Chancellery, Interior Ministry Standardization Council • State representatives 1. Reference architecture, standardization and standards • Representatives of associations 2. Technology and application • Representative of trade union scenarios Labs Network • Representative of science 3. Legal framework 4. Work, education, and training 5. Digital business models 6. Security of networked systems Research Council Secretariat Source: Federal Ministry of Economic Affairs and Energy in Germany, “Structure of the ‘Industrie 4.0’ platform.” Chart 10 Similarities and Differences between Germany and Japan (1) Industrial distribution Germany Agriculture, forestry, and fisheries 31％ Japan (2) Declining birthrate and aging population Mining, manufacturing, and construction 27％ Other industries 0% (a) Distribution of ages of SME managers (b) Birth rates 3.0 % Germany CY 2002 Germany CY 2016 Japan CY 2000 Japan CY 2015 2.5 2.0 1.5 1.0 0.5 100% Germany Japan World average 0.0 Note: Figures are as of CY 2018 for Germany and as of FY 2017 0 CY 2000 for Japan. below 39 40-44 45-49 50-54 55-59 over 60 Sources: Statistisches Bundesamt, "National accounts"; Cabinet Sources: KfW; The Small and Medium Enterprise Agency, "White Paper on Small and Office, "Annual Report on National Accounts for 2017." Medium Enterprises in Japan"; World Bank. (3) Share of exports by SMEs (4) International comparison of "hidden champion" % Germany Japan United Kingdom Note: Horizontal axes are CY for Germany and FY for Japan. The latest figure available for Japan is for fiscal 2015. Sources: OECD, "Exports by Business Size"; The Small and Medium Enterprise Agency, “White Paper on Small and Medium Enterprises in Japan.” China France Italy Switzerland Austria Japan United States CY/FY 2009 num. of firms Germany Note: The three criteria to be considered a "hidden champion" are the following: (a) the firm is among the top three in the global market or is number one for a particular niche business area on the continent where the firm is based, (b) the firm has less than 5 bil. euro in revenue, and (c) the firm is little known to the general public. Source: Hermann Simon, Hidden Champion of the 21st Century.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the B20 Tokyo Summit, hosted by Nippon Keidanren (Japan Business Federation), Tokyo, 15 March 2019.
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March 15, 2019 Bank of Japan Toward Inclusive and Sustainable Development Remarks at the B20 Tokyo Summit hosted by Nippon Keidanren (Japan Business Federation) Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor for me to have the opportunity to give a speech at the B20 Tokyo Summit today. This year, with Deputy Prime Minister and Finance Minister Aso, I co-chair the G20 Finance Ministers and Central Bank Governors Meetings. We are discussing a wide range of issues at the G20, including those related to the Sustainable Development Goals (SDGs). 1 To tackle global challenges such as the SDGs, it is essential for the private and public sectors to cooperate with each other. Therefore, I find it very meaningful for business leaders from the G20 member countries to meet together and have discussions, in parallel with the G20 processes. This year the B20, under the theme of "Realizing Society 5.0 for SDGs," has been discussing innovations in various areas, changes in the business environment, and how to tackle global challenges. Society 5.0 has been proposed by the Japanese government. It is defined as a human-centered society that balances economic advancement with the resolution of social problems by a system that highly integrates cyberspace and physical space. 2 In such a society, the current problems in various areas will be expected to be resolved by cooperation between the private and public sectors through new technologies and innovations. Today, I will first talk about some recent developments toward achieving the SDGs, and then discuss how innovation could be used to pursue inclusive growth under which "no one is left behind," mainly focusing on the financial aspects. I. Recent Trends toward Sustainable Development Since the Industrial Revolution in the 18th century, global economic productivity has been boosted and people's living standards have been drastically enhanced. This rapid economic growth was supported by advancements in industrial technologies such as the internal combustion engine, and by the realization of a large-scale industrial society incorporating The SDGs are global development goals set by the United Nations in 2015. They are made up of 17 goals and 169 targets to be achieved by 2030. The SDGs succeeded the "Millennium Development Goals (MDGs)," established following the adoption of the United Nations Millennium Declaration in 2000. For details on "Society 5.0 for SDGs," see the website of Cabinet Office, Government of Japan. https://www8.cao.go.jp/cstp/english/society5_0/index.html new technologies. It is also true, however, that economic development has had some negative impact globally. Even during the Industrial Revolution, people were troubled by pollution in industrial areas and by poor living conditions in rapidly expanding urban areas. These problems became widespread as industrialization advanced globally. As a result, the modern society, which has developed dynamically based on economic principles such as profit motivation and price mechanisms, is now confronted with a situation of "external diseconomies," a kind of market failure, in economics terminology. It is not easy to resolve this situation. For instance, in the case of climate change due to global warming, an increase in the consumption of fossil fuels in one country now affects other countries, and indeed the entire globe, thereby causing "spatial external diseconomies." Moreover, today's massive consumption of fossil fuels may negatively affect future generations, thereby causing "intertemporal external diseconomies." One solution to external diseconomies may be direct government regulation. However, this might not necessarily be effective enough as all kinds of problems have become increasingly complicated and globalized. In recent years, many positive developments have been made by private companies, public organizations, and international organizations toward solving such problems. First, mechanisms have been used more widely to encourage economic agents to act in accordance with the goals of sustainable development. In regard to environmental issues, for instance, carbon tax and renewable energy subsidies give incentives for private agents to save energy and reduce greenhouse gas emissions. Some countries and companies have started emissions trading through market mechanisms based on allocated amounts of permits to discharge greenhouse gases, thereby internalizing the social costs of external diseconomies. Moreover, many private companies have made public commitments to address climate change as part of their corporate social responsibility (CSR), and their stakeholders, including shareholders, are keenly interested in such commitments. If this trend becomes more common, sustainable development could be realized by not only relying on compulsory measures such as direct control of emissions but also using those mechanisms I mentioned. Second, recent technological innovations have potential to address problems in a way that could not have been considered before. Regarding energy and the environment, industrial products that reduce energy consumption have been developed for a long time, especially in the wake of the oil shock in the 1970s and since concerns over pollution became more widespread. Moreover, dramatic recent developments in digital technologies such as artificial intelligence (AI) and the internet of things (IoT) now allow for the detailed management of energy demand, forecasts of local climate, etc., and are thereby contributing to the further enhancement of energy efficiency. As for emissions trading mentioned earlier, distributed ledger technology has started being used to reduce trading costs and expand markets. In Society 5.0, we are expected to tackle global challenges and realize a sustainable society using these new technologies. II. Inclusive Growth and Technological Innovations -- from a Financial Perspective Needless to say, technological innovations have also brought significant changes to the financial sector, which is closely related to central banks. These changes are important in achieving inclusive growth, one of the key objectives of SDGs. The concept of inclusive growth is that the dividends of economic growth should be distributed fairly across all members of society, leaving no one behind. While the global economy has grown rapidly since the Industrial Revolution, there have been many people who have not been able to enjoy the benefits of growth. Some people have had access to opportunities such as employment, education, and new technologies in various areas, while others have not. Eliminating such disparities has also become an important global concern. In the context of the financial sector, many countries have recognized financial inclusion as an important policy agenda, the idea that no one should be left behind in having access to and getting benefits from formal financial services. What is remarkable here is that the latest advancements in technologies in the financial sector, so-called FinTech, can help to promote financial inclusion.3 The diffusion of mobile payments in emerging and developing countries For details about the wide-ranging impact of FinTech on the financial economy and the engagement of central banks, see the following report. Bank of Japan, Payment and Settlement System Report Annex, FinTech Special Edition, September 2018. is perhaps a typical example of the contribution of FinTech to financial inclusion. New financial services such as cashless payment using smartphones sometimes spread rapidly in regions without the necessary social infrastructure of bank branches and wired communication. This is a phenomenon, known as "leapfrogging," in which people who do not have access to conventional financial services can obtain immediate access to convenient services through new technologies. For instance, in China, payment and settlement services using smartphones offered by e-commerce and social network services (SNS) companies have spread rapidly since around 2013. In major cities, the cashless society has progressed to such an extent that people can quite easily lead their daily lives without cash. Online loan services based on credit risk analysis using AI and big data have also been rapidly deployed so that individuals and small and medium-sized enterprises can access them easily. In Africa, where the holding of bank accounts and access to financial services is limited due to underdeveloped banking industries, financial services such as cash withdrawal and short-term loans using mobile devices have become increasingly accessible. Other examples include mobile payment spreading in small island developing states where the development of financial infrastructure had been constrained. Also, in big cities in Southeast Asia with heavy traffic congestion, mobile payment has developed from ride-hailing services. In this way, FinTech has been applied in accordance with each country's or region's situations. FinTech can therefore contribute not only to economic growth through enhancing convenience and financial intermediation, but also to the resolution of social problems such as financial inclusion. At the same time, there are some notes of caution in regard to the rapid diffusion of FinTech. First, it is necessary to ensure the security of transactions, including cyber security and the protection of personal information. The risks of abuse of these technologies for money laundering and terrorist financing must also be addressed. Moreover, securing the stability of the financial system is important. In particular, the diffusion of FinTech that expands access to credit in countries with weak financial supervision may increase financial stability risks, even though it contributes to financial inclusion.4 III. Role of the Public Sector As I have explained, technological advancements can play a significant role in tackling global challenges such as environmental protection and financial inclusion. What role, then, can the public sector play in addressing these challenges while taking advantage of new technologies? I would like to point out three important roles of the public sector, based on the issues I have raised so far and recent discussions in the G20. First, it is important to support people who cannot fully or readily enjoy the benefits of new technologies. Recently, concerns have been expressed that AI and robots may take over certain occupations. As discussed at the G20 under Argentina's presidency last year, one important role of the public sector is to provide a safety net and opportunities for education and training to those who would be negatively affected by new technologies.5 We should also pay attention to the possibility that people who are less familiar with digital technologies may be left behind. While FinTech can significantly expand access to financial services, people in certain conditions or circumstances may suffer disadvantages from new technologies such as automated credit examination, for instance. In this regard, we have raised the issue of aging and financial inclusion at the G20 under Japan's presidency this year. We will discuss whether the development and diffusion of digital technologies might impede the access to financial services by the elderly, and how to provide convenient and accessible financial services for all. Second, we need to secure economic, financial, and social stability. If unemployment increases and investment declines due to an economic recession or financial instability, it would become harder to address a variety of economic and social issues by introducing new Sahay, R., M. Čihák, P. N'Diaye, A. Barajas, S. Mitra, A. Kyobe, Y. N. Mooi, and S. R. Yousefi "Financial Inclusion: Can It Meet Multiple Macroeconomic Goals?" IMF Staff Discussion Note 15/17, International Monetary Fund, 2015. For a report to the G20 on "the future of work," see http://www.oecd.org/g20/g20_menu_of_policy_options_for_the_future_of_work_fwg-executive_su mmary.pdf technologies. If the abuse of new technologies leads to social disruption and widespread suspicion of technology, the deployment of new technologies would become more difficult. Regarding technological innovations in the financial sector, the G20 has especially focused on crypto-assets and their underlying technology, and has discussed how to contain the various types of risks while harnessing their potential benefits. Third, international cooperation is important. As various issues have become globalized, it is essential for financial authorities to cooperate across regions. For instance, regarding environmental issues, the Financial Stability Board (FSB), comprising central banks and financial authorities from many countries, established an industry-led task force on disclosures of companies' climate-related financial risks and strategies. The task force has made recommendations for consistent company disclosures.6 The G20 has also introduced various multinational initiatives related to environmental issues, including the promotion of infrastructure investment highlighting environmental, social, and governance (ESG) factors. Concluding Remarks Today I have talked about how new technologies can contribute to tackling global challenges such as environmental protection and financial inclusion, and what role the public sector can play. As stressed by Schumpeter about 100 years ago, innovation is driven by entrepreneurs. However, the public sector can play an important role as well in tackling modern global challenges related to the SDGs. The Bank of Japan would like to contribute through taking initiatives toward the healthy development of FinTech, supporting financial institutions which contribute to regional vitalization, promoting financial literacy, as well as securing economic, price, and financial stability. I would like to conclude my remarks here, with the hope that today's discussion at the B20 will stimulate further cooperation between the private and public sectors toward achieving the SDGs. Thank you for your attention. For details, see the reports posted on the task force's website. For example, "Recommendations of the Task Force on Climate-related Financial Disclosures," June 2017. https://www.fsb-tcfd.org
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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, 9 May 2019.
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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, 9 May 2019. * * * I. Economic and Financial Developments in Japan I will first explain economic and financial developments in Japan. Japan’s economy has been on a moderate expanding trend, although exports and production have been affected by the slowdown in overseas economies. Looking at this in more detail, Japan’s exports and production have shown some weakness recently, mainly in terms of capital goods and IT-related goods specific to China. However, domestic demand has continued to be firm. With corporate profits having stayed at favorable levels on the whole, albeit with some weakness observed in part, business fixed investment has continued on an increasing trend. Private consumption also has been increasing moderately, albeit with fluctuations, against the background of steady improvement in the employment and income situation. Going forward, Japan’s economy is likely to continue on a moderate expanding trend, despite being affected by the slowdown in overseas economies for the time being. Risks to the outlook are skewed to the downside, particularly regarding developments in overseas economies, including the consequences of protectionist moves, developments in the Chinese economy, and the degree of progress in global adjustments in IT-related goods. On the price front, the year-on-year rate of change in the consumer price index (CPI) has been positive but has continued to show relatively weak developments compared to the economic expansion and the labor market tightening. Recently, however, firms increasingly have reflected rises in prices of raw materials and personnel expenses in their prices. As such moves continue to spread with the output gap remaining positive, people’s inflation expectations are projected to rise gradually. The momentum toward achieving the price stability target is maintained, and the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent. II. Conduct of Monetary Policy Next, I will explain the Bank’s conduct of monetary policy. The Bank has been conducting powerful monetary easing under the framework of “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control.” In terms of yield curve control, with a view to facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target, the Bank has conducted purchases of Japanese government bonds (JGBs) under the guideline for market operations, in which it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent. Japan’s economy has continued on a moderate expanding trend and already is no longer in deflation in the sense of a sustained decline in prices. However, it is likely to still take time to achieve the price stability target of 2 percent. In addition, there remain high uncertainties regarding the outlook for economic activity and prices including developments in overseas economies. Based on this recognition, the Bank considers it important to make clearer its policy stance to persistently continue with powerful monetary easing toward achieving the price stability target. Thus, the Bank decided last month to clarify forward guidance for policy rates introduced in July 2018 and maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account 1/2 BIS central bankers' speeches uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike. The Bank also decided to take such measures as the expansion of eligible collateral for the Bank’s provision of credit, thereby contributing to smooth fund-provisioning as well as to securing market functioning. These measures likely will strengthen public confidence in continuing with powerful monetary easing, thereby further ensuring the achievement of the price stability target and leading to stability in financial markets. The Bank will continue to examine the risks considered most relevant to the conduct of monetary policy and conduct its policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. Thank you. 2/2 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, 17 May 2019.
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May 17, 2019 Bank of Japan Outlook for Economic Activity and Prices and Monetary Policy Speech at a Meeting Held by the Naigai Josei Chosa Kai (Research Institute of Japan) in Tokyo Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is my pleasure to have the opportunity to address you today at the Naigai Josei Chosa Kai. At the Monetary Policy Meeting (MPM) held at the end of last month, the Bank updated its projections for Japan's economic activity and prices through fiscal 2021 and released them in the April 2019 Outlook for Economic Activity and Prices (Outlook Report). In addition, with a view to making clearer its policy stance to persistently continue with powerful monetary easing, the Bank decided to take some additional monetary policy measures. Today, I would like to talk about the Bank's outlook for Japan's economic activity and prices based on the Outlook Report, as well as its current thinking behind the conduct of monetary policy, including the decision at the recent MPM. I. Economic Developments Developments in Overseas Economies Let me start by talking about developments in overseas economies. Overseas economies have been growing moderately on the whole, but slowdowns have been observed recently (Chart 1). Unlike the synchronous growth of the global economy seen through the first half of last year, differences in growth rates among regions and industries have become evident. While the U.S. economy has continued to expand firmly, relatively weak developments increasingly have been observed in the Chinese economy because economic activity has been hampered by the trade friction between the United States and China as well as adjustments in the IT sector, in addition to the impact of authorities' measures to push forward with deleveraging. As for Europe, production has declined since the second half of last year, mainly in Germany, reflecting the tightening of gas emission regulations on automobiles within the European Union (EU), and weaker exports to Turkey and China also have been exerting downward pressure on the European economy recently. Under these circumstances, in the latest forecasts released by the International Monetary Fund (IMF) last month, the global economic growth rate for 2019 is projected to be 3.3 percent, which was further revised somewhat downward from the previous forecasts released in January. Thus, the growth rate for this year is likely to fall slightly below the long-term average since 1980 of 3.5 percent. Current Situation of Japan's Economic Activity With the global economy decelerating, Japan's exports and production have shown some weakness recently (Chart 2). Exports have decreased since the turn of the year, mainly in terms of capital goods and IT-related goods to China, and this has led to the weakness in production and deterioration in business sentiment in the manufacturing sector. However, weakness in overseas economies so far does not appear to have spread clearly to domestic demand. Business fixed investment has continued on an increasing trend, with corporate profits staying at favorable levels on the whole (Chart 3). According to our March Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment plans for fiscal 2019 showed relatively high growth for this time of the year, exceeding the past average. Private consumption also has been increasing moderately against the background of steady improvement in the employment and income situation. Meanwhile, demand from foreign visitors, which temporarily declined in the second half of last year due to the effects of the successive natural disasters, has recovered clearly again. Thus, in Japan, a virtuous cycle from income to spending has been maintained in both the corporate and household sectors, although some weakness has been observed in exports and production. On this basis, the Bank judges that Japan's economy has been on a moderate expanding trend. As seen in the current economic phase, a situation where the slowdown in overseas economies pushes down Japan's economy also was observed from mid-2015 through the first half of 2016. Many people remember this as the so-called China shock, and not a few have pointed out its similarity with the current phase. However, looking more closely, there also seem to be some differences between then and now (Chart 4). First is the degree of the declines in exports and production. Unlike at the time of the China shock, exports and production fell significantly in the current phase. The fact that the assessment of the Indexes of Business Conditions released by the Cabinet Office this week turned to "worsening" for the first time since January 2013 is largely attributable to the recent declines in production-related indicators. Of course, on this point, it is necessary to take into consideration that these, to some extent, are reactionary declines to significant increases in exports and production in the past few years. In fact, although exports and production have decreased, their levels have remained higher than those during the China shock. Second, developments in financial and commodity markets at home and abroad differ between the two phases. Crude oil prices fell substantially to just below 30 dollars per barrel through February 2016; in the foreign exchange market, the yen rapidly appreciated against the dollar after the turn of 2016, from the range of 120-130 yen to below 100 yen. On the other hand, in the current phase, although crude oil prices and financial markets at home and abroad temporarily became unstable from last autumn through the year-end and the start of this year, they both subsequently have regained stability. We are at least not in a situation where developments in financial markets worsen firms' and households' sentiment and thereby push down economic activity. Third, as I mentioned earlier, domestic demand and business sentiment of the nonmanufacturing sector have been firm in the current phase on the back of favorable corporate profits and improvement in the employment and income situation. Under such circumstances, the output gap, which represents the utilization of capital and labor, exceeded the long-term average of 0 percent in the second half of 2016, and since then has remained clearly positive. Thus, it can be assessed positively that the robustness of Japan's economy against external shocks has been increasing steadily amid the economic expansion that is said to be the longest in the post-war era. Outlook for Economic Activity Next, I will talk about the outlook for Japan's economy. As shown in the Outlook Report, the Bank projects that Japan's economy is likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021 -- despite being affected by the slowdown in overseas economies for the time being (Chart 5). In terms of the median of the Policy Board members' forecasts, the real GDP growth rate is projected to be 0.8 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.2 percent for fiscal 2021. There are two important points regarding this outlook for economic activity (Chart 6). First is future developments in overseas economies. Although slowdowns have been observed recently, the Bank does not consider that overseas economies will continue to deteriorate all the way. The U.S. economy -- the growth engine of the global economy -- is expected to maintain its expansion, mainly supported by expansionary fiscal policy. As for the Chinese economy, the effects of stimulus measures already have materialized in part, and such moves are likely to become more widespread. The European economy is projected to gradually move out of its deceleration phase as the effects of temporary factors such as the tightening of gas emission regulations on automobiles are likely to dissipate. Taking account of these developments, overseas economies are expected to start picking up, although slowdowns are likely to continue for the time being. What matters is the timing of the pick-up. On this point, the IMF forecasts that the global economic growth rate will start rising again in the second half of this year. According to our interviews of firms, not a few hold the view that global demand for IT-related goods will hit bottom in the second half of this year. As overseas economies pick up, Japan's exports are projected to return to their moderate increasing trend without much delay. Of course, there are various uncertainties regarding this outlook. For example, Chinese authorities have been implementing stimulus measures that focus on such factors as tax cuts this time around while taking account of the balance between stimulating economic activity and deleveraging, based on the recognition that large-scale infrastructure investment after the global financial crisis subsequently led to the problems of excess production capacity and excess debt. Thus, whether the recent measures will have immediate effects as in the past may largely affect the timing of a pick-up in overseas economies going forward. Developments in demand for IT-related goods such as semiconductors remain highly uncertain, and there is a possibility that inventory adjustments on a global basis will take longer than expected. The final outcomes of such issues as the trade friction between the United States and China and negotiations on the United Kingdom's exit from the EU also remain unclear. Although there is no need to focus particularly on risk factors and become excessively cautious, the Bank considers it important to constantly examine risks to the outlook without preconception. The second important point in forecasting future developments is the sustainability of domestic demand. In order for Japan's economy to continue expanding moderately without interruption, it is necessary to maintain firm domestic demand until overseas economies pick up. On this point, private consumption is expected to continue increasing moderately for the time being as the employment and income situation continues to improve steadily. The fact that public investment is expected to increase, mainly led by infrastructure investment reflecting policy measures for national resilience, also is likely to contribute to underpinning economic activity going forward. What holds the key is developments in business fixed investment. So far, the impact of the slowdown in overseas economies cannot be observed clearly in business fixed investment plans for this fiscal year, and in the nonmanufacturing sector where labor shortage has continued, many firms seem to have more active investment plans than last year, mainly regarding labor-saving investment. However, business fixed investment plans at this time of the year have a strong tendency to be based on rough estimates, and attention should be paid to the possibility that firms' investment stance will become cautious in mainly the manufacturing sector, if a pick-up in overseas economies takes longer than expected going forward. As I mentioned earlier, the robustness of Japan's economy has increased, mainly on the back of favorable corporate profits. Nevertheless, the Bank will closely monitor future developments as there is a possibility that firms' and households' sentiment will be affected depending on developments in overseas economies and financial markets. II. Price Developments Current Situation of Prices Next, I will talk about price developments. The year-on-year rate of change in the consumer price index (CPI) has continued to show relatively weak developments compared to the economic expansion and the labor market tightening (Chart 7). However, the basic mechanism has been operating in which a positive output gap -- a rise in the level of economic activity -- results in moderate increases in wages and prices. For example, at this year's annual spring labor-management wage negotiations, the rate of increase in base pay started out lower than last year in early spring, mainly for large firms, but thereafter the rate of increase for small and medium-sized firms turned out to be relatively high, due to such factors as acute labor shortage. Eventually, the rate of increase in base pay as a whole was at about the same level as last year. The year-on-year rate of increase in hourly wages of part-time employees also has continued to mark relatively high growth in the range of 2-3 percent. Such developments, together with a rise in prices of raw materials, will lead to an increase in costs for firms. Thus, firms have been proceeding with reflecting these rises in prices of their products and services, albeit slowly (Chart 8). Looking at the diffusion index (DI) for output prices in the Tankan, the situation has continued for over a year in which the proportion of enterprises answering that the output prices have risen exceeds the proportion of those answering that such prices have fallen. This has occurred for the first time in about 30 years since the bubble period. Prices of services traded in the corporate sector also have risen steadily, mainly against the background of an increase in distribution costs accompanying labor shortage. From consumers' perspective, moves to raise retail prices have been spreading recently, mainly in terms of food products. Of course, a rise in prices of food products and daily necessities is not favorable for households, if focusing only on the rise. What is important is that the employment and income situation improves to an extent that households can accept such price rises. The Bank's monetary policy also aims at creating a virtuous cycle in which the inflation rate rises moderately in line with increases in corporate profits and wages. With a view to further pushing forward with such a virtuous cycle, the Bank strongly hopes that positive efforts by both labor and management toward raising wages will become more widespread. Outlook for Prices Let me now move on to the outlook for prices. In the latest Outlook Report, the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI excluding fresh food are 1.1 percent for fiscal 2019, 1.4 percent for fiscal 2020, and 1.6 percent for fiscal 2021, which is the end of the projection period (Chart 9). As this shows, the pace of increase in the CPI in Japan is likely to remain moderate. While there are various reasons for this, one of them is that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched, due mainly to the experience of prolonged low growth and deflation, and changing this is expected to take time. This past experience and people's cautious mindset based on it lead to a situation where prices in Japan will not rise easily, due mainly to two channels. The first is the possibility that firms' stance will not shift as much as theoretically expected toward further raising wages and prices, even when the output gap improves. Both labor and management in Japan still have a persistent tendency to place priority on the stability of employment over wage increases, due mainly to the experience of severe employment adjustments under deflation. One example of this situation is the fact that the pace of increase in wages has been sluggish compared to the degree of labor shortage. The second channel is that it is likely to take time for inflation expectations to rise. Per orthodox thinking, a mutual feedback between actual prices and inflation expectations is assumed to operate. That is, if actual prices increase, people's inflation expectations also will rise, and if inflation expectations rise, actual prices also will increase. If firms and households expect that wages and prices will not increase easily, this feedback will not operate smoothly. In this context, recent studies point out that people's inflation expectations tend to depend not only on developments in actual prices, but also individuals' experiences over a long period. Thus, there also is a possibility that average inflation expectations will not rise readily as the ratio of the generation that has spent much of their life under deflation increases. However, there is no need to be too pessimistic about the current situation. It is a significant change in Japan's economy that the year-on-year rate of change in the CPI excluding fresh food has remained at a level close to 1 percent for more than one year, owing to an improvement in the output gap. The behavior and mindset under deflation also have been changing gradually, as evidenced by the fact that base pay increases have been conducted for six consecutive years (Chart 10). Under such circumstances, although inflation expectations have remained more or less unchanged on the whole, those of mainly households recently have risen somewhat. As people have gained the collective experience of increases in wages and prices in the past few years, it is likely to contribute to pushing up inflation expectations going forward. In this way, the momentum toward achieving the price stability target has been maintained, whereby a positive output gap results in an increase in actual prices, leading to a rise in inflation expectations. The Bank projects that the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent, although this will still take time. III. The Bank's Conduct of Monetary Policy Now, I would like to explain the Bank's conduct of monetary policy. The Bank currently adopts the policy framework of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control." Under the framework, it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent, and has conducted purchases of Japanese government bonds (JGBs) in the market so that the yield curve would be formed in line with this guideline (Chart 11). By conducting this operation, short- and long-term interest rates in financial markets have been stable at low levels and lending rates for firms as well as issuance rates for corporate bonds also have remained at extremely low levels. The Bank aims at achieving the price stability target of 2 percent at the earliest possible time through powerful monetary easing centered on yield curve control. Meanwhile, at the MPM held at the end of last month, Policy Board members shared the recognition that there are high uncertainties regarding the outlook for economic activity and prices in Japan, including developments in overseas economies, and that it is likely to still take time to achieve the price stability target. Based on this recognition, the Bank judged it important to make it clearer that its policy stance to persistently continue with the current powerful monetary easing toward achieving the price stability target has not changed (Chart 12). Thus, it decided at the April MPM to clarify forward guidance for policy rates introduced in July 2018. Forward guidance is a measure that makes clear the stance on future policy rates in advance in order to strengthen market confidence and expectations regarding monetary policy. Specifically, a part of the existing guidance was revised, thereby making clear that the Bank would "maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike." The point of this revision is that a specific period of "at least through around spring 2020" was added to clarify the meaning of "for an extended period of time," during which the Bank intends to maintain the current interest rate levels. This takes into consideration that (1) pick-ups in overseas economies and the global cycle for IT-related goods are expected to be seen in the second half of this year or onward and (2) it is projected to take some time to examine the effects of the scheduled consumption tax hike after its implementation. On this basis, I would like to reemphasize that the current forward guidance is a framework in which the Bank makes judgments depending on economic and price developments by using data and information available at the time, as it says that the Bank will make judgments, taking into account uncertainties regarding economic activity and prices. While economic activity and prices are likely to remain in a state where the current extremely low levels of short- and long-term interest rates would be appropriate, at least through around spring 2020, the Bank considers that there is a fair possibility that the current low interest rates will be maintained beyond this period depending on future developments. In addition, the Bank also decided at the MPM held at the end of last month to implement various measures contributing to the continuation of the current powerful monetary easing. Specifically, it decided on such measures as expanding the range of eligible collateral for such purposes as the Bank's lending to financial institutions, and relaxing the terms and conditions for the facility of temporarily lending Japanese government securities (JGSs) held by the Bank. In addition, the Bank decided to consider the introduction of a facility for lending exchange-traded funds (ETFs) that it holds to market participants. While I will not explain these measures in detail today, they all will provide support for continuing with powerful monetary easing through the Bank's smooth fund-provisioning and securing of market functioning. In combination with the clarification of forward guidance, these measures likely will strengthen public confidence in continuing with powerful monetary easing, thereby contributing to further ensuring the achievement of the price stability target and leading to stability in financial markets. Given economic developments in Japan, where prices and inflation expectations have not risen easily, the Bank considers it necessary to maintain a positive output gap for as long as possible by keeping interest rates at sufficiently low levels for a prolonged time, in order to achieve the price stability target. Some measures that I outlined earlier also are based on such thinking. In this way, central banks always consider the most appropriate monetary policies for their respective situations, with a view to achieving their objective of price stability. This does not only apply to Japan. For instance, the U.S. Federal Reserve has been proceeding with monetary policy normalization for the past few years, such as through incrementally raising its policy interest rate. After the turn of the year, however, it temporarily stopped raising the policy interest rate due to such factors as the slowdown in the global economy, even though interest rate levels still have been quite low compared to the time before the global financial crisis. In addition, central banks abroad, including the Federal Reserve, recently have worked on reviewing their monetary policies after the global financial crisis and discussing new monetary policy frameworks as well as specific tools. In my understanding, the background to such moves is that (1) the real interest rate neutral to economic activity, or the natural rate of interest, has been on a declining trend in many advanced economies in recent years, mainly reflecting a decrease in the potential growth rate and a constant excess of funds, and (2) difficulties in enhancing the effectiveness of monetary policy under such circumstances have been taken into consideration. Of course, Japan and economies such as the United States cannot be treated in the same way. However, many central banks currently face a common fundamental challenge of how to achieve the price stability target while securing stability in economic and financial conditions, in a situation where room for monetary policy responses has been narrowing compared to the past due to low growth and low inflation. While continuously keeping this challenge in mind, the Bank deems it necessary to follow developments in discussions abroad as appropriate. Conclusion So far, I have explained economic and price developments in Japan and the Bank's thinking behind the conduct of monetary policy based on such developments. I would like to close my speech today by adding a few words. More than two weeks have passed since the Heisei era drew to a close and the Reiwa era has started. While monetary policy is not classified in terms of the imperial era, I think that the Heisei era can be characterized by a continuous battle against deflation when looking back from the perspective of a central bank. In the situation of a prolonged economic downturn after the so-called bubble burst, it became difficult to further reduce short-term interest rates in order to stimulate the economy after around 1998 -- about a decade following the start of the Heisei era. Incidents such as the global financial crisis and the Great East Japan Earthquake also were tough challenges for Japan's economy, which was seeking to move out of deflation. In order to overcome the zero lower bound on short-term interest rates amid such challenges, the Bank has worked on conducting unconventional monetary policies ahead of many other economies, such as introducing forward guidance and purchasing a variety of assets. Six years ago, the Bank introduced QQE, which is a more powerful measure than before, and has persistently continued with powerful monetary easing. Under such circumstances, Japan's economy has improved significantly over the past few years and successfully reached the end of the Heisei era in a situation where the economy was no longer in deflation in the sense of a sustained decline in prices. While the imperial era has changed, the Bank's mandate of aiming at achieving price stability, thereby contributing to the sound development of the national economy, has not. Going forward, the Bank will continue to make its utmost efforts as the central bank of Japan with a view to fulfilling this mandate while responding appropriately to the constantly changing developments in economic activity and prices. Thank you very much for your attention. Outlook for Economic Activity and Prices and Monetary Policy Speech at a Meeting Held by the Naigai Josei Chosa Kai (Research Institute of Japan) in Tokyo May 17, 2019 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Economic Developments Overseas Economies Projections for Major Economies (IMF) y/y % chg., % points Projection 3.8 3.6 Advanced economies 2.4 2.2 United States 2.2 2.9 Euro area 2.4 1.8 Japan 1.9 0.8 4.8 4.5 China 6.8 6.6 ASEAN-5 5.4 5.2 Latin America and the Caribbean 1.2 1.0 World Emerging market and developing economies Projection 3.3 3.6 (-0.2) (0.0) 1.8 1.7 (-0.2) (0.0) 2.3 1.9 (-0.2) (0.1) 1.3 1.5 (-0.3) (-0.2) 1.0 0.5 (-0.1) (0.0) 4.4 4.8 (-0.1) (-0.1) 6.3 6.1 (0.1) (-0.1) 5.1 5.2 (0.0) (0.0) 1.4 2.4 (-0.6) (-0.1) Note: The post-2019 figures are based on April 2019 WEO projections. Figures in parentheses show the differences from the January 2019 projections. Source: IMF. Chart 2 I. Economic Developments Exports and Production Real Exports Industrial Production s.a., CY 2015=100 s.a., CY 2015=100 CY 10 Sources: Ministry of Finance; Bank of Japan; Ministry of Economy, Trade and Industry. CY10 Chart 3 I. Economic Developments Business Fixed Investment and Private Consumption, etc. Business Fixed Investment s.a., ann., tril. yen Private nonresidential investment (SNA, real) Private Consumption Inbound Tourism Demand s.a., CY 2011=100 Consumption Activity Index (travel balance adjusted, real) CY09 10 11 12 13 14 15 16 17 18 19 Number of foreign visitors to Japan CY05 s.a., ann., mil. persons CY 10 11 12 13 14 15 16 17 18 19 Notes: 1. In the middle chart, figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption. 2. In the right chart, seasonally adjusted figures are BOJ staff estimates. Sources: Cabinet Office; Bank of Japan; JAPAN NATIONAL TOURISM ORGANIZATION, etc. Chart 4 I. Economic Developments Comparison between the Present and around 2015-2016 Crude Oil Prices and Yen/U.S. Dollar Exports and Production s.a., CY 2015=100 Real exports U.S. dollar/bbl Industrial production yen/U.S. dollar Crude oil (Brent, left scale) Yen/U.S. dollar (right scale) "Favorable" -5 Nonmanufacturing (large enterprises) Nonmanufacturing (small enterprises) -10 -15 CY12 DI ("favorable"-"unfavorable"), % points Business Conditions DI (Nonmanufacturing Sector) CY14 Sources: Ministry of Finance; Bank of Japan; Ministry of Economy, Trade and Industry; Bloomberg. -20 CY12 "Unfavorable" Chart 5 I. Economic Developments BOJ's Forecasts of Real GDP (April 2019 Outlook Report) s.a., ann., tril. yen Fiscal 2021 +1.2% Fiscal 2019 +0.8% Fiscal 2018 (y/y % chg.) +0.6% Fiscal 2020 +0.9% FY 12 Note: Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Cabinet Office; Bank of Japan. Chart 6 I. Economic Developments Key Points for the Future Domestic Demand Sustainability (Business Fixed Investment Plans in the Tankan) Developments in Overseas Economies (IMF World Economic Outlook) 6.0 growth rates, ann., % y/y % chg. average (FY 2004-2017) 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Advanced economies Emerging market and developing economies World economy 0.0 16:H1 16:H2 17:H1 17:H2 18:H1 18:H2 19:H1 19:H2 FY 2019 FY 2015 FY 2017 -2 Mar. June Sept. FY 2016 FY 2018 Dec. Forecast Actual Notes: 1. In the left chart, figures for the world economy are calculated as the weighted averages of growth rates of advanced economies as well as emerging market and developing economies using GDP shares of world total GDP from the IMF as weights. 2. In the right chart, figures are all industries including financial institutions. Including software and R&D investment and excluding land purchasing expenses (R&D investment is not included until the December 2016 survey). There is a discontinuity in the data in December 2017 due to a change in the survey sample. Sources: IMF; Bank of Japan. Chart 7 II. Price Developments Consumer Prices y/y % chg. -1 CPI (all items less fresh food) -2 CPI (all items less fresh food and energy) -3 CY 85 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 8 II. Price Developments Firms' Price-Setting Stance Output Prices DI (Tankan) 20 DI ("rise"-"fall"), % points Services Producer Price Index (SPPI) 1.5 y/y % chg. Large enterprises 1.0 Small enterprises 0.5 -10 0.0 -20 -0.5 -30 -1.0 -40 -50 CY 85 SPPI (all items excluding international transportation) -1.5 CY11 Notes: 1. In the left chart, there is a discontinuity in the data in December 2003 due to a change in the survey framework. 2. In the right chart, figures are adjusted for changes in the consumption tax rate. Source: Bank of Japan. Chart 9 II. Price Developments BOJ's Forecasts of the CPI (April 2019 Outlook Report) 2.0 y/y % chg. Fiscal 2020 Fiscal 2019 +1.4% CPI (all items less fresh food) Fiscal 2021 +1.6% (y/y % chg.) +1.1% 1.5 1.0 0.5 0.0 -0.5 -1.0 FY 12 Notes: 1. Forecasts are the medians of the Policy Board members' forecasts (point estimates). The actual figures exclude the direct effects of the consumption tax hike in April 2014. 2. The direct effect of the scheduled consumption tax hike on the CPI for fiscal 2019 and fiscal 2020 is estimated to be 0.5 percentage point for each year. The direct effects of policies concerning the provision of free education on the CPI for fiscal 2019 and fiscal 2020 are estimated to be minus 0.3 percentage point and minus 0.4 percentage point, respectively. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 10 II. Price Developments Environment Surrounding Prices Nominal Wages y/y % chg. Inflation Expectations 2.5 Base pay increase for full-time employees Scheduled cash earnings per fulltime employee y/y, ann. avg., % Market participants (QUICK, 2 to 10 years ahead) Economists (6 to 10 years ahead) Households (Over the next 5 years) 2.0 Firms (5 years ahead) 1.5 1.0 -1 FY 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 0.5 0.0 CY 05 Notes: 1. In the left chart, figures for scheduled cash earnings from fiscal 2013 are based on corrected figures adjusted for establishments in Tokyo with 500 or more employees, and from fiscal 2016 are based on continuing observations following the sample revisions of the "Monthly Labour Survey." 2. In the right chart, figures for economists are from the "Consensus Forecasts." Figures for households are from the "Opinion Survey on the General Public's Views and Behavior," estimated using the modified Carlson-Parkin method. Figures for firms are "Outlook for General Prices (Tankan, all industries and enterprises, average)." Sources: Ministry of Health, Labour and Welfare; Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Bank of Japan; QUICK, "QUICK Monthly Market Survey (Bonds)"; Consensus Economics Inc., "Consensus Forecasts." Chart 11 III. The Bank's Conduct of Monetary Policy Yield Curve Control % 0.6 Recent JGB yield curve 0.5 1.0 % Introduction of QQE Introduction of "QQE with Yield Curve Control" 0.8 Target level of the long-term interest rate: around zero percent 0.4 0.3 0.2 Short-term policy interest rate: minus 0.1 percent 0.1 0.6 Strengthening the Framework for Continuous Powerful Monetary Easing 0.4 0.2 0.0 0.0 -0.1 -0.2 -0.2 -0.3 Long-term interest rates (10-year JGB yields) -0.4 0 1 2 3 4 5 6 7 8 9 10 15 20 residual maturity, year CY 13 Source: Bloomberg. III. The Bank's Conduct of Monetary Policy Chart 12 Continuation of Powerful Monetary Easing (April 2019) High uncertainties regarding economic activity and prices including developments in overseas economies Still taking time to achieve the price stability target Making clearer the Bank's policy stance to persistently continue with powerful monetary easing Clarification of forward guidance for policy rates July April "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike." Implementation of measures contributing to the continuation of powerful monetary easing Smooth implementation of fund-provisioning and asset purchases (1) Expanding eligible collateral for the Bank's provision of credit (2) Improving the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth Securing market functioning (3) Relaxation of the terms and conditions for the Securities Lending Facility (SLF) (4) Introduction of Exchange-Traded Fund (ETF) Lending Facility
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bank of japan
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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, Nagasaki, 22 May 2019.
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May 22, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Nagasaki Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Nagasaki Branch. As you all know, Japan's growth rate, which until the 1980s was the highest among major developed countries, has declined since the 1990s. Low growth started in the 1990s, so it has lasted for three decades. Those who know nothing but low growth are already in their forties. And those who have happy memories of entering the job market during the bubble period and remember suffering through the collapse of asset prices are already in their fifties. Many people say that they do not really mind if economic growth is low -- there are more important things than the economy. But if you tell them that low growth will lead to lower pensions, everyone will reply: "Well, that's a problem." The Scandinavian countries, with their comprehensive welfare systems, are all economically wealthier than Japan. Moreover, people lose their generosity and ability to make rational judgments when the economy is in trouble. You will probably agree if, for example, you think back to Japan's path from the Showa Depression of 1930-31 to the war. It is important for the economy to be in a good state. Based on these considerations, there are a number of issues I will talk about today. First, I would like to consider Japan's low growth by dividing GDP growth into the three factors determining growth -- growth in capital input, labor input, and total factor productivity (TFP), which can be regarded as representing technological progress -- and look at Japan's performance in comparison with other countries. Second, linked to this low growth, I will talk about why the 2 percent price stability target is needed. Third, I will talk about the link between the "high-pressure economy" and growth. Fourth, I will explain the relationship between low interest rates and banks' profitability. And fifth, I will elaborate on recent economic developments and monetary policy. 1. Japan's Low Growth and Growth Accounting from an International Perspective Let us look at Japan's low growth from an international perspective. In what follows, I will divide growth into growth in capital input (information and communication technology [ICT] capital as well as other capital), labor input, and TFP. The reason for dividing growth into these three factors is that considering each factor individually provides some understanding of how the growth rate could be raised. Let us take a moment to have a look at the estimates for member countries provided by the Organisation for Economic Co-operation and Development (OECD). Specifically, Chart 1 presents the average growth rates for three subperiods for each of the seven major OECD economies and the averages for these economies as a group.1 The blue line in the charts shows that, while Japan still enjoyed comparatively high growth during 1985-95, growth subsequently stalled, and from the mid-1990s it registered slower growth than the other countries except Italy. However, following the introduction of bold monetary easing -- quantitative and qualitative monetary easing (QQE) -- in 2013, Japan's growth rate recovered somewhat, and with growth in the other countries slowing, Japan's low growth is no longer that conspicuous.2 Data provided by the OECD are also employed in Chapter 1, Section 3 of the 2018 White Paper on Information and Communications in Japan released by the Ministry of International Affairs and Communications. Figure 1-3-2-2 of the White Paper arrives at similar conclusions to my speech today. Using the dataset employed by the Bank of Japan's Research and Statistics Department and the Cabinet Office to estimate the output gap and potential GDP, somewhat different results from those using the OECD data are obtained regarding the contribution of growth in TFP and capital input. 2 To simplify the chart, the period 1985-95 is shown. Since the high growth registered in Japan during the second half of the 1980s was due to the bubble, combining this period with the first half of the 1990s, when the bubble burst, provides a better representation of the underlying growth trend. See Harada Yutaka, "Jissho keizaigaku wa ikanaru shinjitsu o terashi dashi taka," in Ushinawareta 10 nen no shinin wa nanika, ed. Iwata Kikuo and Miyagawa Tsutomu (Tokyo: Toyo Keizai, 2003). Chart 1 Decomposition of Structures of Economic Growth in Major Countries Based on Growth Accounting Japan % % 10 4 U.S. % % -1 1985-95 1995-2012 U.K. % 0 -1 2012-17 % 10 4 1985-95 % 1995-2012 2012-17 Germany % -1 -1 1985-95 % 1995-2012 France 2012-17 % 10 4 1985-95 % 1995-2012 Italy 2012-17 % -1 1985-95 1995-2012 Canada % 0 -1 2012-17 % 10 4 1985-95 1995-2012 G7 countries' average % 2012-17 % -1 -1 1985-95 1995-2012 2012-17 TFP ICT capital Real GDP Real GDP per capita 1985-95 1995-2012 2012-17 Non-ICT capital Labor CPI Yields on 10-year government bonds (right scale) Note: Real GDP per capita is GDP per capita expressed in terms of real purchasing power parity in U.S. dollars as of 2010. ICT capital denotes information and communications technology capital. The starts to time series of yields on 10-year government bonds differ according to their availability. Japan's growth accounting data for 2017 are estimated using the Cabinet Office's System of National Accounts. Sources: Cabinet Office, "System of National Accounts"; OECD, "Level of GDP per capita and productivity," "Growth in GDP per capita, productivity and ULC"; IMF, "World Economic Outlook Database"; Bloomberg. Next, the bars in the charts provide a breakdown of GDP growth into changes in the contribution of capital input, labor input, and TFP. As can be seen, in Japan, capital input, labor input, and TFP growth all decelerated in 1995-2012, and thus all three contributed to the decline in growth overall. In 2012-17, growth recovered somewhat as a result of a recovery in the contribution of labor input and TFP.3 However, while the average annual growth rate of the seven countries since 2012 has been 1.6 percent, Japan's growth rate, at 1.3 percent, remains low. That said, the reason that the growth rate of many of the other countries is higher than Japan's is the higher growth rate of labor input. While labor input on average in the other countries has contributed 0.6 percentage point to GDP growth, it has contributed only 0.2 percentage point in Japan. However, because labor input growth in Japan in 1995-2012 actually made a negative contribution of 0.4 percentage point, the recovery to small but positive labor input growth has made a substantial contribution to the recovery in Japan's overall economic growth since 2012. The reason for the relatively large contribution of labor input in most of the other countries is that these countries recently have seen an increase in their population, mainly due to immigration. The fact that labor input in Japan has made only a small contribution to growth overall means that, on a per capita basis, Japan's growth rate has been on par with that of the other countries. In fact, in terms of real purchasing power parity GDP per capita, Japan's growth rate of 1.4 percent is higher than the 1.1 percent average of the seven countries. While it frequently had been argued that the decline in Japan's growth rate during the 1990s was due to a decline in TFP growth, it has been concluded that other factors also have substantially contributed to the slowdown, such as a deceleration in labor quality improvements, a decline in labor input, a deceleration in capital accumulation, and a decline in capacity utilization. For details, see the following references. Motohashi Kazuyuki, "IT investment and productivity growth of Japan's economy and comparison to the United States (available only in Japanese)," RIETI Discussion Papers, no. 02-J-018, November 2002, https://www.rieti.go.jp/jp/publications/summary/02110001. html. Kawamoto Takuji, "What Do the Purified Solow Residuals Tell Us about Japan's Lost Decade?," Monetary and Economic Studies, vol.23, no.1, February 2005. Kwon Hyeog Ug and Fukao Kyoji, "Ushinawareta 10-nen ni TFP jyōshō wa naze teitai shitaka -- Seizōgyō kigyō dēta ni yoru jisshō bunseki," chap. 3 in Keizai seido no jisshō bunseki to sekkei, vol.1 Keizai teitai no genin to seido, ed. Hayashi Fumio (Tokyo: Keiso Shobo, 2007). Moreover, in the case of Japan, another factor that has contributed to the recovery in economic growth is the recovery in TFP growth. The contribution of TFP growth -- at 1.0 percent -- has been higher than the average of the seven countries, which is 0.6 percent. I think that the recovery in TFP growth is partly due to the contribution of the "high-pressure economy," which I will talk about later. On the other hand, the contribution of capital input has further declined from 1995-2012, dropping to 0.2 percent. This is lower than the average of the seven countries, which is 0.4 percent. Moreover, dividing capital input growth into growth in ICT capital and other capital shows that input growth in both is lower than the average of the seven countries. It could be said that, in Japan, the contribution of capital to economic recovery is insufficient, and so is capital investment. I will return to this issue later. Looking at the seven countries, most of them have been experiencing declining growth, as indicated by the blue line in the charts. Countries growing faster than Japan have been able to do so due to population growth including immigration. While low growth has been a problem in Japan since the late 1990s, it has now become a global problem. At the same time, inflation also has been falling. Until the 1980s, developed countries -especially Italy and the United Kingdom -- were suffering from high inflation, so hardly anyone in the world was concerned about the possibility of falling prices, which now is a major issue. In Japan, from the mid-1990s onward, it has been pointed out that deflation has led to sluggish output growth, exacerbating the nonperforming-loan problem and the fiscal deficit problem.4 While the United States and the United Kingdom struggled to maintain positive inflation, they somehow succeeded. However, the situation seems different in the case of continental Europe. For example, as seen in the charts, inflation in Germany, France, and Italy has not reached 1 percent in 2012-17, so it can be said that they are under deflationary pressure. Meanwhile, Japan has recovered from the deflation observed in 1995-2012, but the rate of increase in the consumer price index (CPI) has not yet reached 1 percent. Iwata Kikuo, "Naze keiki no teimei ga tsuzuku no ka?," chap. 2 in Nihon gata byōdō shakai wa horobu no ka (Tokyo: Toyo Keizai, 1995). Furthermore, interest rates also have been declining. While this reflects the decline in real growth rates and in inflation, it seems there are additional factors that play a role.5 2. Why Is the 2 Percent Inflation Target Important? As mentioned earlier, not only Japan but other major countries also are suffering from low growth and low inflation. In addition, countries in continental Europe have been unable to achieve their inflation targets, which aim at 2 percent. So, why is inflation of 2 percent important? Some argue that if other countries cannot achieve 2 percent inflation, Japan will not need to accomplish this target. The Bank has cited three reasons why achieving 2 percent inflation is important.6 My interpretation of the Bank's view can be summarized as follows. First, aiming at achieving 0 percent inflation entails the risk of actually aiming for deflation, given the upward bias of the CPI. Second, the equilibrium interest rates -- which are achieved in the long run -- tend to be lower on a nominal basis when the aim is 0 percent inflation. That being the case, there will be virtually no room for lowering interest rates should the economy fall into recession. In order to avoid this, it is necessary to provide a so-called buffer for nominal interest rates by raising the inflation rate. Third is the global standard. Given that other major countries aim at achieving 2 percent inflation, if Japan were the only country with a lower target, this would result in an appreciation of the yen, which would create turmoil in firms' investment plans. If Japan maintains the same inflation rate as other countries, I feel that this will serve to stabilize foreign exchange over the long term. On this point, I explained interest rate declines in relation to declines in the real GDP growth rate and the inflation rate as well as structural changes in the supply of and demand for funds in Harada Yutaka, "Naze nihon no kinri wa hikui no ka," Keiki to saikuru, no. 62, Japan Association of Business Cycle Studies, November 2016. In addition, the relationship between monetary policy and interest rates is explained in Ben S. Bernanke, "Why are interest rates so low?" Brookings Institution, March 30, 2015, https://www.brookings.edu/blog/ben-bernanke/2015/03/30/why-are-interest-ratesso-low/. The Cabinet Office raises the decline in capital goods prices and heightening demand for safe assets as factors behind interest rate declines in Cabinet Office, Sekai keizai no chōryū 2016 nen II, chap. 1, section 1, January 2017. 6 Haruhiko Kuroda, "Overcoming Deflation and After: Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo," Bank of Japan, December 2013. Of these theories, I consider the buffer theory of interest rates within the second point to be the most important and would like to provide my view on it. This theory is completely different from the one advocated by the Bank in the past. The previous theory aimed at raising interest rates preemptively even when the economic recovery was insufficient, because if interest rates were too low, it would be difficult to implement stimulus measures during recessions. Such monetary policy resulted in a complete failure. The buffer theory should be interpreted as raising interest rates after confirming that price increases have gained enough momentum. This theory posits that interest rates will rise due to inflation. I would like to emphasize that the Bank's current thinking on the buffer theory is totally different from the previous incorrect one. Private banks' business consists of borrowing short-term debt and financing long-term lending. The higher long-term interest rates are relative to short-term rates, the larger banks' loan margins will be. Since short-term interest rates generally do not rise as much as long-term rates, banks naturally will gain profits if interest rates go up due to an increase in the inflation rate. So, why did banks want a hike in interest rates as early as possible? Maybe they have not been sufficiently aware of the mechanism that lowering interest rates to stimulate the economy will lead to a rise in inflation and hence in nominal interest rates, or maybe they have been aware of this mechanism but were so desperate for a rise in interest rates that they could not wait. Moreover, there are many who say that the Bank's large-scale asset purchases and negative interest rate policy are unusual, and thus the policy must be "normalized" as early as possible.7 However, they never explain on what basis policy should be regarded as usual or unusual. Termination of the zero interest rate policy in 2000 and of quantitative easing in 2006 can be regarded as attempts to "normalize" monetary policy, but these proved to be major failures. The premature tightening of monetary policy gave rise to concerns about a deterioration in the economy, and the spread between short- and long-term interest rates See, for example, Yamakawa Tetsufumi, "Deguchi no meiro, kin'yū seisaku o tou 22, Seifu no 'datsu defure sengen' uke seijyōka e," Shūkan Ekonomisuto, March 13, 2018, https://www.weekly-economist.com/20180313bojexit/. actually declined rather than increased.8 Similarly, in the United States and Europe, the spread between such rates has been declining. This is said to be because of the cooling of the economy brought about by the monetary tightening implemented so far. If interest rates were raised immediately in Japan now, the spread between short- and long-term interest rates likely would be reversed. Moreover, there is another reason for the Bank's committing to the 2 percent inflation target; namely, that we cannot fully grasp the actual strength of the economy at present. Specifically, we do not actually know the exact structural unemployment rate, which represents the limit below which any further decline in the rate gives rise to inflation. If the Bank had terminated monetary easing based on estimates that the structural unemployment rate was around 3.5 percent or lower, the current unemployment rate of 2.0-2.5 percent would not have been achieved.9 In fact, I think that we probably will be able to achieve an even lower unemployment rate. The reason why lower unemployment was achieved and a bubble has not occurred is because the inflation rate is set as the direct target for monetary policy. Moreover, given the rise in wages, nonmanufacturing firms are making progress in streamlining business processes and making labor-saving investment. In other words, For more on this point, see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Ishikawa," Bank of Japan, July 2018. 9 The following publications showed that the structural unemployment rate was around 3.5 percent or lower using unemployment-vacancy analysis: Ministry of Health, Labour and Welfare, Analysis of the Labour Economy 2015, September 2015; Cabinet Office, Annual Report on the Japanese Economy and Public Finance 2015, August 2015; and Bank of Japan, "The Bank's View" in the Outlook for Economic Activity and Prices (hereafter the report), October 2014. The Bank, from the April 2015 report, deleted the description regarding the structural unemployment rate from the main text of "The Bank's View" and added the following in a footnote to it: "This rate [the structural unemployment rate] is calculated to be around 3.5 percent or lower recently under a specific methodology." Then, from the April 2016 report, this description was deleted from that footnote and instead moved to a footnote to "The Background." From the July 2016 report, the actual level of the structural unemployment rate referred to in that footnote was replaced by the following expression: "the structural unemployment rate defined here differs from the concept of Non-Accelerating Inflation Rate of Unemployment (NAIRU), and does not show a direct relationship with prices or wages." The chart presenting the structural unemployment rate had long been published in the "The Background," and it indicated that the rate gradually had been declining from the range of 3.0-3.5 percent. The rate exhibited a sharp drop to around 2.5 percent in the April 2018 report, before the chart was removed from "The Background" in the July 2018 report. having a clear inflation target made it possible to implement bold monetary policy and bring about a recovery of the economy. At the international conference entitled "Central Banking in a Changing World," hosted by the Bank's Institute for Monetary and Economic Studies (IMES) in May 2018, Professor Athanasios Orphanides of the Massachusetts Institute of Technology, the Honorary Advisor to IMES -- who served as the Governor of the Central Bank of Cyprus and was then a member of the Governing Council of the European Central Bank (ECB) -- commented that lack of clarity on the precise definition of price stability made the Bank reluctant to engage in decisive quantitative easing and instead willing to accommodate too-low inflation. However, he also said that, following the clarification of the definition as 2 percent in terms of the year-on-year rate of increase in the CPI in 2013, a dramatic reorientation of monetary policy took place, and the decisive QQE introduced in the same year has been gradually reflating the economy while simultaneously improving Japan's government debt dynamics.10 III. The "High-Pressure Economy" and Real Economic Growth Monetary easing measures stimulate the economy, bring about labor shortages, and exert pressure on the economy to grow. While there are a variety of channels through which such a "high-pressure economy" results in higher real growth rate, I would like to consider this in terms of the results of growth accounting mentioned earlier.11 Following the introduction of QQE, Japan's real growth rate recovered due to increases in growth in labor input as well as TFP. However, capital input both in terms of ICT capital as well as other capital has been decelerating. The reason why labor input increased is because QQE succeeded in stimulating the economy. While the number of unemployed will increase during a recession, those that have been unemployed will start to work during an economic upturn, and with the Athanasios Orphanides, "The Boundaries of Central Bank Independence: Lessons from Unconventional Times," Monetary and Economic Studies, vol.36, no.4, November 2018. 11 I have explained these channels in Harada Yutaka, "Nihon keizai to seisansei: Special Lecture at a Conference Commemorating Daiwa Institute of Research's 200th Release of Japan's Economic Outlook," Bank of Japan, March 2019. improvement in the employment situation, those who had given up looking for work will also actively look for work again and then start working. As a result, labor input increases. Moreover, because a recession means that there is less work, those who fortunately have had a job will try hard not to lose it. Amid a lack of jobs, the so-called black firms will take advantage of their employees that do not want to lose the job they managed to get, subjecting them to harsh working conditions. 12 Meanwhile, large firms, because they cannot easily lay off employees, will be saddled with a lot of dissatisfied employees with an uncertain career and future. Under these circumstances, profits and productivity are unlikely to grow. When the economy expands, low-productivity work tends to be reduced. In times of recession, sales fall and retailers, restaurants, and so forth will try to increase demand, even if only a little, by extending their business hours. The opposite occurs during an economic upturn. If there are labor shortages, restaurants that used to stay open until midnight will start to close early. If they open only during the busiest times of the day and in the evening, labor productivity will increase. If there are labor shortages, this makes it possible for people to switch jobs. Those working at black firms will flee while those with an uncertain career and future will also try to relocate in order to obtain new jobs. Since they will move to firms that value them more highly, the economy's overall productivity will increase. This is not only a matter of productivity. Engaging in a job in which they are valued more highly also raises their degree of happiness. In other words, levels of both productivity and happiness rise at the same time, and so will that of TFP. Lastly, let me explain capital input. Why is capital input not increasing? This is similar to asking why investment is not increasing in line with profits. Reasons for this include low growth expectations, the self-fulfilling nature of growth expectations, and sluggish growth in domestic business fixed investment caused by the strong appetite for overseas For examples of black firms, see Konno Haruki, Burakku kigyō, Nihon o kuitsubusu yōkai (Tokyo: Bunshun Shinsho, 2012). investment.13 The latter reflects concerns over a shrinking of the domestic market due to the declining population and the experience of intermittent surges in the value of the yen amid its appreciating trend up until the introduction of QQE. Of these reasons, what I think is particularly noteworthy is the self-fulfilling nature of growth expectations. Low growth in the past and intermittent surges in the yen will reduce growth expectations and the expected rate of return on investment. Therefore, in order for investment to recover, continued high growth and stable exchange rates are vital. From 2012 until today, average annual growth has remained just above 1 percent, the exchange rate has been stable, and investment has been recovering, but most recently we appear to have entered a more difficult phase. This is something I will discuss when talking about recent economic developments later. IV. Low Interest Rates and the Profitability of Private Banks As I have explained, while low interest rates have led to labor shortages and are likely to have contributed to increased productivity and happiness, it frequently is argued that they undermine the profitability of private banks.14 However, I think that deterioration in banks' profitability actually is caused by the structural problem that they are accumulating deposits despite there being no borrowers. Let me examine what would have happened to banks' profitability if the Bank did not conduct bold monetary easing, namely QQE. From the time of the introduction of QQE up until February 2019, loans by domestically licensed banks increased by 71 trillion yen while deposits increased by as much as 144 trillion yen.15 I think that banks typically would react positively to monetary policy that allows them to increase loans by as much as 71 trillion yen; on the contrary, they express considerable criticism and dissatisfaction. This is because deposits are growing faster than loans, which makes it difficult for some banks to invest these funds. Of course, deposits will rise as lending increases as a result of the money multiplier mechanism, but this mechanism See Naoya Kato and Takuji Kawamoto, "Corporate Profits and Business Fixed Investment: Why are Firms So Cautious about Investment?" Bank of Japan Review, no. 16-E-2, April 2016, https://www.boj.or.jp/en/research/wps_rev/rev_2016/data/rev16e02.pdf.; and Aoki Daiju and Shikano Tatsushi, "Shotoku ga nobitemo shishutsu ga nobinai no wa naze ka," chap. 4 in Abenomikusu no shinka, ed. Harada Yutaka and Masujima Minoru (Tokyo: Chuokeizai-sha, 2018). 14 See, for example, "Mienu 'deguchi,' fukusayō zōdai: ginkōkai ni takamaru fuman -- mainasu kinri 3 nen," Jiji Press, February 15, 2019, https://www.jiji.com/jc/article?k=2019021500887&g=eco. 15 Bank of Japan, Financial Institutions Accounts. alone does not lead to an increase in deposits twice as large as the increase in loans. In my opinion, if banks are struggling to invest funds, it might be better if they tried not to accumulate deposits. In this context, news reports suggest that regional financial institutions are struggling to attract personnel and that staff members are retiring early.16 While this is reported as though it is troublesome, it consequently could lead to a reduction in the number of personnel assigned to collecting more deposits than needed and in that of branches. I think that this would increase the productivity of the banking sector, and thus of Japan's economy as a whole. I am aware, of course, of the criticism that the decline in the number of bank branches would reduce convenience for users, and thus banks should not close branches.17 However, banks would decide to close such branches because they only have few customers in the first place. I agree with the argument that having a deposit account should be regarded as a basic human right, but there are many other places to make a deposit account, such as post offices, agricultural and fishery cooperatives, credit cooperatives, convenience stores, and supermarkets that provide banking services. Deposit accounts can be held in a range of places nowadays. To examine the impact of the Bank's easing policy on banks' profits, Chart 2 compares the actual deposit-taking and lending-related profit as a result of the increase in lending and decline in interest rates since the introduction of QQE (where profit is calculated by subtracting interest on deposits from interest on loans) as well as hypothetical deposit-taking and lending-related profit had QQE not been introduced. In particular, two counterfactual scenarios are considered. In the first, Case 1, it is assumed that without QQE See, for example, the 2-day series, Minami Takero and Nakatani Shogo, "Chigin haran jinzai kokatsu no kiki," Nikkei, February 20 and 21, 2019. 17 Yamaneko, "Keizai kishōdai ginkō no kyogaku sonshitsu, dare no tame," the Asahi Shimbun, March 26, 2019. The article describes how deterioration in banks' profits has started to undermine users' convenience -- for example, branches that people nearby have frequented have closed and/or some other branches have stopped providing services for corporate clients, allowing use only by individual clients. lending would not have increased and interest rates would have continued declining, following the past trend. Next, although I think that it is correct to assume that interest rates would have continued to drop as a trend due to the decline in prices and in real GDP growth rate, as pointed out earlier, the second counterfactual scenario, Case 2, assumes that interest rates would not have declined. Chart 2 Simulation of Deposit-Taking and Lending-Related Profit tril. yen Introduction of QQE 6.0 5.8 5.6 5.4 5.2 5.0 4.8 4.6 4.4 4.2 4.0 FY 2011 Actual values Case 1 Case 2 Note: All banks (domestic business sector). Deposit-taking and lending-related profit is calculated by subtracting interest on deposits (including negotiable certificates of deposits) from interest on loans (including bills discounted). In Case 1, data from fiscal 2013 onward -- those for yields on loans, yields on deposits, amount outstanding of loans, and amount outstanding of deposits and negotiable certificates of deposits -- were estimated using the trends calculated from the time-series data from fiscal 2002 through 2012. In Case 2, the only difference from Case 1 is that figures for yields on loans from fiscal 2013 onward were set at the same level as that of fiscal 2012. Sources: Japanese Bankers Association, "Zenkoku ginkō kessan happyō," "Financial Statements of All Banks"; Bank of Japan, "Financial Institutions Accounts." Comparing the actual deposit-taking and lending-related profit with the hypothetical cases, the profit in Case 1 in fiscal 2017 would have been 0.2 trillion yen higher than the actual profit. In Case 2, it would have been 1 trillion yen higher. Adding up the differences from fiscal 2013, the cumulative total would be 0.9 trillion yen in Case 1 and 3.4 trillion yen in Case 2. However, the economy improved, stocks rose, and interest rates declined due to QQE, so credit costs have decreased and realized gains/losses on stockholdings and bondholdings have increased as a result of QQE. If we cumulate these gains/losses from fiscal 2013, they reach 4.0 trillion yen by fiscal 2017, which is greater than the cumulative total in Case 1 or 2 during the same period.18 It could be said that, until fiscal 2017, banks' profits were actually higher as a result of QQE than they would have been otherwise. The argument that banks' profits have decreased as a result of QQE is based on the implausible assumption that profits would have increased by more if only interest rates had not declined, completely ignoring the fact that the decline in interest rates brought about the improvement in the economy. Calculated by adding realized gains/losses on bondholdings, realized gains/losses on stockholdings, and credit costs of major banks (non-consolidated) as well as regional banks (non-consolidated). Data are taken from the Bank's Financial System and Bank Examination Department's annual Financial Results of Japan's Banks for each fiscal year from fiscal 2013 through 2017 (those for fiscal 2014 are available only in Japanese). V. Recent Economic Developments and Monetary Policy I have talked about the importance of creating a "high-pressure economy" with the monetary easing policy. I now would like to talk about recent economic developments. Charts 3 and 4 provide an overview of key economic indicators. Almost all the indicators -for production, investment (the aggregate supply of capital goods), exports, and world trade -- had been improving. However, there are many indicators that are falling currently. Chart 3 Production, Investment, Exports, and World Trade Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 s.a., CY 2012 = 100 Introduction of QQE with Yield Curve Control Sep. 2016 └ └ └ └ Industrial production Aggregate supply of capital goods └ └ └ World trade volume Real exports └ 19 Sources: Ministry of Economy, Trade and Industry, "Indices of Industrial Production," "Indices of Industrial Domestic Shipments and Imports"; CPB Netherlands Bureau for Economic Policy Analysis, "CPB World Trade Monitor"; Bank of Japan, "Developments in Real Exports and Real Imports." Chart 4 looks at wages, employment, employee income (wages multiplied by the number of employees), and consumption. 19 Real wages per worker have not increased, but real In my past speeches, I defined real employee income as the number of regular employees multiplied by real wages based on the Monthly Labour Survey. However, taking into account the decline in the level of the number of regular employees for January 2018, I have redefined real employee income as the product of the number of employed based on the Labour Force Survey and real wages based on the Monthly Labour Survey. employee income (real wages multiplied by the number of employees) has grown more or less steadily except for fiscal 2014, the year of the consumption tax hike. The unemployment rate also has declined. Among the different indicators, the one showing weak improvement is real consumption. Consumption as measured by the consumption activity index is still below the level in 2013; that is, before the spike in demand due to the frontloading of purchases prior to the consumption tax hike. However, it is true that consumption generally has been recovering. Chart 4 Employment, Income, and Consumption Inauguration Introduction Consumption Expansion Introduction of of the second of QQE tax hike of QQE QQE with a Negative Abe Cabinet Apr. 2013 Apr. 2014 Oct. 2014 Interest Rate Dec. 2012 Jan. 2016 Introduction of QQE with Yield Curve Control Sep. 2016 s.a., CY 2012 = 100 % 5.0 4.5 4.0 3.5 3.0 2.5 2.0 └ └ └ └ └ └ └ └ 19 Number of employees Consumption activity index (travel balance adjusted, real) Real wages Real employee income Consumption rate (real consumption divided by real employee income) Unemployment rate (right scale) Note: Real employee income is calculated as the number of employees multiplied by real wages, which is total cash earnings deflated by the CPI (all items less imputed rent). The consumption rate is calculated as the consumption activity index (travel balance adjusted, real) divided by real employee income. Sources: Ministry of Health, Labour and Welfare, "Monthly Labour Survey"; Ministry of Internal Affairs and Communications, "Consumer Price Index," "Labour Force Survey"; Bank of Japan, "Consumption Activity Index." As mentioned earlier, the economy has been recovering due to QQE. However, exports and production have been declining since the second half of 2018, given, for example, the sluggish world trade volume. I consider that there is a risk of these declines spreading to employment and consumption. Also, there are a number of risks to economic activity going forward, such as the conduct of economic policy in the United States, trade friction between the United States and China, the United Kingdom's exit from the European Union (EU), developments in the European economy, and a slowdown of the Chinese economy. It also should be noted that, in Japan, a consumption tax hike is scheduled to take place in October 2019. Challenges for Achieving the Price Stability Target of 2 Percent The economy has been weak recently, and the same can be said about prices. According to the most recent data, the year-on-year rate of change in the CPI for all items less fresh food for March was only 0.8 percent, and that for all items less fresh food and energy was only 0.4 percent. Even so, if the economy continues to recover under the current monetary policy, the labor market will tighten and prices eventually will rise. There are some hurdles to overcome in achieving stable price rises, however. First is the difficult situation the economy currently faces, as you already are familiar with. Second is consumption tax hikes. Tax hikes could push the economy into recession, and a resultant decrease in demand could push down prices. Regarding the hike scheduled to take place in October 2019, its effects are likely to be smaller than those of the previous hike in April 2014 due to the following reasons: the rate increase -- from 8 percent to 10 percent -is smaller than that of the previous hike; a reduced tax rate will be applied to some items; permanent measures such as those concerning the provision of free education will be implemented; and a variety of measures are to be taken so as to smooth out the effects of the front-loaded increase in demand and its fallback. However, the effects of the previous tax hike, which many economists had expected to be limited, have proved significant and lasting. There is a possibility that a decline in demand, such as the one seen after the previous hike, naturally would contain inflation. The third hurdle is price declines associated with the scheduled consumption tax hike. Measures concerning the provision of free education will be implemented alongside the hike. The Bank estimates that the price rises brought about by the hike and the effect of prices being pushed down due to the provision of free education will together push up the year-on-year rate of change in the CPI for all items less fresh food for fiscal 2019 and 2020, by 0.2 and 0.1 percentage point, respectively. In addition, I would like to mention another factor that is not directly related to the consumption tax hike. It is the planned reduction in charges for mobile phone services recently announced by some of the major mobile network operators in Japan. Although many of the details are uncertain and it depends on the prerequisites for such details, many analyses seem to suggest that it would push down the year-on-year rate of change in the CPI for all items less fresh food by 0.1 to 0.3 percentage point. 20 Assuming that these estimations are correct, achievement of the 2 percent price stability target inevitably would be delayed, in accordance with the degree of reduction. Regardless of these setbacks, I am not too pessimistic. The provision of free education and a reduction in mobile phone-related prices are no different from tax cuts, and people's real income increases by an amount equivalent to the degree of price declines. Although it likely will take time for an increase in real income to induce an increase in actual demand, this will not hamper the achievement of the 2 percent price stability target itself. This also could be said about other price declines, including those in crude oil prices. Nevertheless, there is a risk that the current sluggishness in observed prices will spill over to inflation expectations, further delaying inflation. To prepare for uncertainties accompanying the scheduled consumption tax hike and overseas economic outlook, the Bank clarified its forward guidance and decided to implement measures contributing to the continuation of monetary easing at the Monetary See, for example, Kato Azusa and Kono Ryutaro, "Economic Spotlight, keitai ryōkin 4 wari hikisage no inpakuto: CPI ni wa 0.3 pointo teido no inpakuto ka," BNP Paribas Securities (Japan) Limited, April 2019 and Tonouchi Shuji, "Fandamentaruzu nabigētā, keitai shinryōkin ni yoru CPI shitaoshi kōka wa yahari genteiteki to narisō," Mitsubishi UFJ Morgan Stanley Securities, April 2019. Policy Meeting held on April 25, 2019.21 I considered it desirable to clarify the forward guidance but continued to oppose the policy proposal. This was because I considered that the Bank should indicate data-dependent guidance -- such as "the Bank intends to maintain the current levels of short- and long-term interest rates unless prices show stronger movements than currently anticipated" -- to further clarify its relationship with the price stability target.22 Concluding Remarks In my speech today, I examined Japan's economy since the 1980s using growth accounting and at the same time looked at the effects of monetary policy during this period. What this showed is that monetary policy has the ability to raise productivity not only from a short-term perspective but also from a long-term perspective. On the other hand, there is also a deep-rooted argument that bold monetary easing undermines the profitability of private banks. In this regard, I pointed out that this argument appears to ignore the positive impact of the overall economic recovery on banks' profitability. Lastly, I talked about the current state of Japan's economy and monetary policy. At present, domestic demand such as business fixed investment and consumption has withstood the decline in external demand and production. However, it also is true that downside risks to the economy are increasing. The impact of the consumption tax hike scheduled for October this year also is a concern. If the economy deteriorates to the extent that achieving the 2 percent price stability target in the long term becomes difficult, I view it as necessary to strengthen monetary easing without delay. Thank you for your attention. See, Bank of Japan, "Statement on Monetary Policy" and its Attachment, April 2019. For my opinion regarding data-dependent forward guidance, see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Yamanashi," Bank of Japan, March 2019.
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the T20 Summit, Tokyo, 27 May 2019.
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May 27, 2019 Bank of Japan Global Economy: Challenges and Policy Responses Keynote Speech at the T20 Summit Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor for me to deliver this keynote speech at the T20 Summit. This year, Japan assumes the G20 presidency for the first time. The G20 Finance Ministers and Central Bank Governors Meeting in Fukuoka is fast approaching. I will be co-chairing the meeting with Deputy Prime Minister and Finance Minister Aso. We will be discussing various key issues regarding the global economy and finance. The T20, as an international forum for think tanks, has also debated a wide range of issues on the global economy, along similar lines to the G20 discussions, and has provided policy proposals. I believe those proposals from think tanks, with their expertise and unique viewpoints, provide valuable input for public sector policy management. Needless to say, it is important that the private and public sectors exchange views, learn from each other, and engage in constructive dialogue, in order to provide and implement better policies. Today, I would like to talk about the challenges and policy responses to the current situation in the global economy, hoping that my speech will contribute to the discussions at the T20 Summit. Specifically, I would like to elaborate on the medium-term challenges such as global imbalances and international financial architecture. Before going into those issues, let me begin with recent developments in the global economy. I. Recent Developments in the Global Economy The global economy registered high growth up to the first half of last year, but it has decelerated since then, particularly in China and the euro area. Several factors account for this deceleration. First, there has been increased uncertainty regarding economic policy on a global level such as trade tensions and the Brexit negotiations. This has put downward pressure on corporate investment and international trade in capital goods. Second, at the same time, the so-called silicon cycle has entered a downturn, something we have observed many times in the past. Until the first half of last year, there was a claim that the "super-cycle" in demand for semiconductors was on a rising trend. According to the claim, semi-conductor demand would increase steadily over the medium term. However, as was seen in the past, there have been some cancellations of multiple orders for parts and capital goods, together with downward revisions to final goods such as smartphones. In addition to these two global factors, region-specific factors have contributed to the recent deceleration in the global economy. The Chinese economy has shown some weakness due to the lingering impact of deleveraging policy measures, together with trade tensions. In the euro area, exports have decelerated, automobile production has been hampered by delays in adjusting to new emissions regulations, and business sentiment have deteriorated due to heightened uncertainty regarding political and economic conditions. In short, these several factors have contributed to the slower pace of growth in the global economy. What then are the prospects for the global economy? The most recent World Economic Outlook from the International Monetary Fund (IMF), published in April, indicates that the global economy will regain positive momentum during the second half of this year. First, economic policy measures in China and other regions will gradually begin to take effect. China has decided to implement or has already implemented a range of policy measures since the second half of last year, including fiscal and monetary policies. Some Asian emerging economies are also expected to increase fiscal expenditures. In emerging economies in general, monetary policy space has increased as the Federal Reserve has adopted a patient stance regarding its policy normalization. Concerns over capital outflows, currency depreciation, and heightened inflation have also eased relative to last year. Second, production adjustments are likely to show progress in IT-related goods. Manufacturers in Asia, including those in Japan, are now in an adjustment phase, but production of electronic parts is expected to turn around and increase gradually in due course. However, there remains a high degree of uncertainty regarding these prospects, and the downside risks are large. Among them, I will touch upon four risk factors here. The first is the impact of trade tensions. Although trade negotiations seem to have progressed somewhat, a number of issues remain to be resolved. Due to the widening range of tariff increases, trade costs may rise, and corporate activity could be subdued due to reconsideration of production sites and global value chains. The second risk is the effects of economic policy measures, such as those in China. China has implemented a range of tax reduction measures, together with an increase in infrastructure investment. The effect of these tax reductions, however, depends on the extent to which households and firms increase their spending. Households' and firms' spending is affected by their sentiments and prospects for the economy. Since we have seen heightened uncertainty regarding, for example, trade tensions, we should be cautious about the effectiveness of these policy measures. The third risk comes from political factors. In addition to Brexit and political uncertainties in Europe, political destabilization due to increasing income inequality could affect the global economy through a decline in confidence and instability in financial and capital markets. The fourth risk is vulnerability arising from accumulated debt in the private and public sectors. The accumulation of public debt is the result of an increase in public expenditure after the Lehman shock and rising social security payments. There is no doubt that such expenditures have had a positive impact on the economy. However, securing long-term fiscal sustainability is a precondition for maintaining economic stability. While accumulated private debt may be the result of positive investment, such as corporate and housing investment, it does increase the financial vulnerability of firms and households, making them susceptible to changes in interest rates and financial market conditions. We therefore need to be vigilant about such risks. At each G20 meeting, we share our understanding on global economic conditions and associated risks, and we discuss the necessary policy measures. Of course, the global economy is changing continuously. In the run-up to the June G20 meeting in Fukuoka, we will remain vigilant about these changes, while gathering all the necessary information. As president of the G20, we will lead policy discussions at the meeting with all the relevant information and appropriate evaluations of global economic conditions. II. Global Imbalances Among the G20 policy agendas, let me focus on two medium- to long-term issues: global imbalances and international financial architecture. First, on global imbalances. Although the issue has long been a topic for discussion at G20 meetings, we have had limited opportunity in the recent past to discuss it in great depth. We have therefore decided to put the issue on the table of G20 meetings again this year. We will analyze the trend and background of global imbalances and discuss the appropriate policy actions. Looking back on the global trend before the Lehman shock, we saw excess consumption and investment on the back of soaring asset prices in the United States, and an expansion in current account deficit as the mirror image of these domestic excesses. On the other hand, emerging economies took a cautious approach to investment, partly because of the trauma of past balance-of-payment crises, and as a result, their current account surplus accumulated. When asset prices plunged and domestic demand shrank in the United States, the savinginvestment balance subsequently recovered. The expanding trend of U.S. current account deficit stopped. Meanwhile, emerging economies experienced a deterioration in trade balances due to the slowdown of the global economy triggered by the global financial crisis. The increasing trend of their current account surplus stopped. It is not necessarily true that deficit is bad and surplus is good with regard to global imbalances. As textbook macroeconomics tells us, the current account is equivalent to the domestic saving-investment balance. It is not appropriate to judge whether it is in a good situation or not merely by seeing if there is a deficit or surplus. For example, it is better for emerging economies with high growth potential to borrow abroad, invest at home, and realize higher economic growth. On the other hand, for countries with limited growth opportunities, it is better to invest abroad and earn higher returns. In these circumstances, countries with abundant investment opportunities are more likely to see investment exceed savings, resulting in a current account deficit. Meanwhile, countries with limited growth opportunities see savings exceed investment, hence a current account surplus. Optimal saving-investment balances and associated current account balances differ from country to country, depending on individual circumstances. What we need to determine is whether the actual savinginvestment balances and current account balances have diverged from the optimal levels that reflect economic fundamentals. If the balances do not reflect economic fundamentals, we then need to examine whether or not this divergence is the result of disequilibrium of the economy and finance and inappropriate policy measures. In order to realize sustainable and balanced economic growth, we cannot overlook excess current account imbalances that are not in line with fundamentals. Bilateral trade measures will not help resolve such imbalances. These are primarily issues for multilateral and macro saving-investment consideration. Global imbalances will be discussed intensively at the G20 meeting this year. In particular, we will promote understanding that we need to examine whether the current levels of global imbalances are appropriate or excess, taking into account the importance of structural factors such as aging. III. International Financial Architecture Along with global imbalances, international financial architecture has also long been on the agenda at the G20 meetings. The global economy has suffered the enormous negative impact of financial and economic crises such as the Asian crisis in the late 1990s, the global financial crisis after the Lehman shock, and the subsequent European sovereign debt crisis. To prevent such crises from occurring again, each country must implement the appropriate economic policies to avoid accumulating economic and financial sector imbalances. Looking back on history, we have seen how asset bubbles in stocks and real estate, as well as excessive lending by financial institutions, have contributed to overheating the economy, and vice versa, and how current account deficits and accumulated external debt have become the source of crises. One lesson history teaches us is that, by helping to stem the source of crises, appropriate economic policy management is definitely the first line of defense in crisis prevention. Rigorous monitoring of the global economy and financial conditions is crucial to detecting the early signs of crisis. With this in mind, we intensively examine global economic and financial conditions at every G20 meeting. Of course, experience has taught us the difficulty of prior detection of excessive activities and imbalances. That is why we also need to prepare crisis management policy tools to prevent crises from spreading. The IMF's lending facilities play a crucial role in such crisis management. One of the important functions of the IMF is to provide short-term lending to a country with a balance-of-payments crisis. The IMF's role in times of crisis has become even more important as international trade and financial transactions have expanded. Besides the IMF lending in times of crisis, regional financing arrangements (RFA) are also expected to be used. In Asia, the Chiang Mai Initiative Multilateralization (CMIM) is one such arrangement. Japan, China, Korea, and the ASEAN countries participate in the initiative. Once a crisis occurs, each country is expected to provide the funds necessary to prevent the crisis from spreading. In order to mobilize funds promptly, there is the so-called de-link portion of the fund. This portion comprises 30 percent of the total funds, and is not directly linked to the lending from the IMF. We have also seen an expansion in bilateral swap agreements. When a crisis occurs, countries can use a swap agreement to exchange their currency for another in order to obtain the funds needed for international transactions. In short, we now have multiple layers of measures to cope with global financial crises, with IMF lending playing the central role, supplemented by regional financing arrangements and bilateral swap agreements. Thanks to this enhancement of international financial architecture, together with the strengthening of financial regulations following the global financial crisis, it is fair to say that the resilience of the global economy and financial system has been increased. Nevertheless, it is important to remain vigilant as global financial and economic conditions continue to evolve dramatically. A key element of surveillance is ensuring that no potential sources of crisis have been overlooked. We have seen rapid and revolutionary innovations in information and communication technologies in particular, and financial activities could expand beyond the scope of current regulatory and surveillance frameworks. We have also seen the migration of financial activities to the non-banking sector as regulations on the banking sector have been tightened. To address such non-traditional flows of funds, it may be necessary to expand the tools used and the range of data subject to surveillance in order to detect signs of a crisis. The policy actions of individual countries and international coordination to tackle the imbalances identified by such surveillance are also important issues for discussion. In addition to monetary and fiscal policy, macroprudential policy measures are increasingly used to address these financial imbalances. Macroprudential policy measures such as countercyclical capital buffers, stress testing, and regulatory measures on lending are all valuable areas for the exchange of ideas and mutual learning. To enhance crisis management in international finance, we need to continue discussing the appropriate modalities for the facilities provided by different entities. Concluding Remarks As I have mentioned, there are a number of important issues to be considered regarding the current state of the global economy. We will be discussing these issues at the G20 meetings this year. The analyses and policy proposals from think tanks provide invaluable input for our discussions, especially considering the wide range of issues related to the global economy. I would like to conclude my speech with the hope that today's T20 Summit will prompt further collaboration between the private and public sectors. Thank you very much for your attention.
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2019 BOJ-IMES Conference "Central bank design under a continued low inflation and interest rate environment", hosted by the Institute for Monetary and Economic Studies and the Bank of Japan, Tokyo, 29 May 2019.
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May 29, 2019 Ba n k o f J a p a n Opening Remarks at the 2019 BOJ-IMES Conference Hosted by the Institute for Monetary and Economic Studies, Bank of Japan Haruhiko Kuroda Governor of the Bank of Japan I. Introduction Good morning. I am honored to welcome such distinguished guests from around the globe to the 25th BOJ-IMES Conference. On behalf of the conference organizers, I thank all the guests in this room. This year’s conference is titled “Central Bank Design under a Continued Low Inflation and Interest Rate Environment.” The current theoretical framework for monetary policy was developed before the Global Financial Crisis. At that time, inflation and interest rates in most advanced economies – with Japan being the notable exception – were high enough to make conventional monetary policy effective. To stimulate the economy, central banks had sufficient safety margins to reduce short-term nominal interest rates. After the Global Financial Crisis, however, this situation changed significantly. Both inflation and nominal interest rates have remained far below their pre-crisis levels for more than a decade. In my opening remarks, I will briefly review the policy agenda for central banks at the moment under a continued low inflation and interest rate environment. II. Policy Agenda under a Continued Low Inflation and Interest Rate Environment This year’s conference focuses on four topics: the monetary policy framework, monetary policy instruments, the relationship between price stability and financial stability, and spillovers to emerging and developing economies. A. Monetary Policy Framework Regarding the monetary policy framework, textbook New Keynesian models assume that long-term inflation expectations are anchored around the inflation target and the central bank sets the policy rate mechanically referring to the natural rate of interest. When these assumptions hold, all that the central bank needs to do to stimulate the economy is to keep real interest rates below the natural rate of interest. However, this conventional policy framework currently faces two major challenges. The first challenge concerns the question to what extent policy makers should rely on the natural rate as a benchmark for monetary policy conduct. This problem is partly associated with the difficulty of measuring the natural rate of interest.1 Of course, this problem can be overcome to some extent by looking at common trends in a range of estimates of the natural interest rate. In fact, various recent estimates of the natural rate of interest suggest that the current level appears to be much lower than before, giving rise to concerns about a secular decline in the natural rate of interest. The other major challenge is related to the stability of long-term inflation expectations under “missing inflation.” In fact, a good number of advanced economies have experienced very sluggish price developments in spite of significant improvements in economic activity. This raises concerns over the credibility of inflation targets, since central banks’ track record in hitting their target provides the foundation for the credibility of such targets. Japan’s experience shows that it is difficult to re-anchor long-term inflation expectations from inflation below the target level. That suggests the importance of maintaining well-anchored inflation expectations. At the same time, if missing inflation comes from structural factors such as globalization and digitalization, central banks should continue examining how best to manage inflation expectations, while securing stability in economic and financial conditions, within the flexible inflation targeting framework. B. Monetary Policy Instruments Regarding the monetary policy instruments, under normal circumstances, central banks pursue their mandate by adjusting short-term nominal interest rates. However, following the Global Financial Crisis, central banks have been forced to find alternatives – policy instruments that are often labeled as unconventional such as forward guidance and the active use of the size and composition of their balance sheet – to overcome the effective lower bound on nominal interest rates. The recent experience with regard to unconventional policy shows that such new tools are effective to counter massive adverse shocks even after hitting the effective lower bound. At the same time, our understanding of unconventional monetary policy is limited. In fact, while policy makers have developed a wide range of unconventional policy tools, their effectiveness and transmission mechanisms may differ depending on See, for example, Powell (2018b). financial conditions and economic structure. It is also important to explore how central banks should use those unconventional policy tools in the future. In that regard, an interesting question is: will those unconventional policy tools become conventional policy tools in normal times? C. The Relationship between Price Stability and Financial Stability Regarding the relationship between price stability and financial stability, it is increasingly recognized that the prolonged low interest rate environment raises two major issues. The first issue is that continued low interest rates can change the risk-taking behavior of financial institutions and affect financial stability. Along this line, two types of risks have been pointed out. The first is that low interest rates lead banks to take excessive risks, and the second is that any further cuts in policy interest rate beyond a “reversal interest rate” discourage risk-taking by banks. While empirical studies on this issue have been accumulating, they are not conclusive about the nature of risks including their probability distribution. 2 The second issue is how to implement policy instruments for safeguarding financial stability. To address this issue, two different approaches are explored. One approach proposes a division of labor in the policy toolkit based on the Tinbergen rule: that is, monetary policy instruments are assigned to the pursuit of price stability, while macroprudential policy instruments are assigned to the achievement of financial stability. 3 The other approach is to “lean against the wind,” that is, monetary policy instruments are implemented not just to achieve the price stability goal but also give due consideration to financial stability goals, under the premise that monetary policy influences broad areas of financial activities.4 It should be noted that, however, a wide range of people including those supporting the first approach recognize that no macroprudential policy toolkit is perfect, and that a key part of the second approach is to stave off a catastrophic financial disruption rather than to moderate financial cycles in an orderly manner. In that regard, the two approaches should not be regarded as For example, Maddaloni and Peydró (2011) documents findings consistent with the first type of risks, and Heider, Saidi, and Schepens (2018) shows a negative relationship between the policy rate and lending volume. See, for example, Svensson (2010). See, for example, Borio and Lowe (2002) and White (2006). completely different ones. D. Spillovers to Emerging and Developing Economies Regarding the spillovers, clearly, one of the issues on the policy agenda relating to prolonged low inflation and interest rates is challenges for emerging and developing economies. The reason is that such an environment in advanced economies could amplify capital flows into emerging and developing economies where inflation and interest rates tend to be higher. Although these capital inflows help boost domestic economic activity, they also carry the risk of economic disruptions such as a sudden outflow of capital or losses by borrowers due to exchange rate fluctuations. Recently, there has been a growing awareness among developing and advanced economies of the potential adverse impact of volatile capital flows.5 III. Conclusion We are now about to start the 25th BOJ-IMES Conference. Following my remarks, this year’s Mayekawa lecture will be given by the former president of the European Central Bank, Mr. Jean-Claude Trichet. I am looking forward to hearing his views based on his long experience in macroeconomic policy management in the euro area. In the keynote speech, Professor Carl Walsh of the University of California, Santa Cruz, the new Honorary Adviser to IMES, will share his views on monetary policy frameworks under a low inflation and interest rate environment from an academic perspective. As the author of the textbook Monetary Theory and Policy, which is a must-read for central bank economists, and of various other significant contributions to the literature, he is one of the most influential academics in this field. Next, the paper presentations will focus on the following four topics: first, optimal monetary policy taking international capital inflows into account; second, the reversal interest rate; third, the Tinbergen Rule for financial stability and price stability; and fourth, the impact of prolonged low nominal interest rates on banking stability. The final and concluding session will be the policy panel discussion, moderated by See Powell (2018a) for the current view of the Federal Reserve Board. See Rajan (2015) for a discussion of the spillover. Professor Athanasios Orphanides of the Massachusetts Institute of Technology, another Honorary Adviser to IMES. As panelists, we will have Mr. Christian Hawkesby, Assistant Governor of the Reserve Bank of New Zealand; Mr. Klaus Masuch, Principal Adviser to the Director General Economics of the European Central Bank; and Mr. Masazumi Wakatabe, Deputy Governor of the Bank of Japan. I hope that the theoretical and practical discussions in this conference will deepen our understanding of central bank design under a continued low inflation and interest rate environment. Thank you for your attention. References Borio, Claudio E. V., and Philip William Lowe, “Asset Prices, Financial and Monetary Stability: Exploring the Nexus,” BIS Working Paper No. 114, Bank for International Settlements, 2002. Heider, Florian, Farzad Saidi, and Glenn Schepens, “Life below Zero: Bank Lending under Negative Policy Rates,” ECB Working Paper Series No. 2173, European Central Bank, 2018. Maddaloni, Angela, and José-Luis Peydró, “Bank Risk-Taking, Securitization, Supervision, and Low Interest Rates: Evidence from the Euro-Area and the U.S. Lending Standards,” Review of Financial Studies, 24(6), 2011, pp. 2121–2165. Powell, Jerome H., “Monetary Policy Influences on Global Financial Conditions and International Capital Flows,” speech at “Challenges for Monetary Policy and the GFSN in an Evolving Global Economy,” Eighth High-Level Conference on the International Monetary System sponsored by the International Monetary Fund and Swiss National Bank, in Zurich on May 8, 2018a. Powell, Jerome H., “Monetary Policy in a Changing Economy,” speech at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium on “Changing Market Structure and Implications for Monetary Policy,” in Jackson Hole on August 23–25, 2018b. Rajan, Raghuram G., “Competitive Monetary Easing: Is It Yesterday Once More?” Macroeconomics and Finance in Emerging Market Economies, 8(1–2), 2015, pp. 5–16. Svensson, Lars E. O., “Monetary Policy after the Financial Crisis,” presentation at the Second International Journal of Central Banking Fall Conference in Tokyo on September 17, 2010. White, William R., “Is Price Stability Enough?” BIS Working Paper No. 205, Bank for International Settlements, 2006.
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Institute of International Finance (IIF) Spring Membership Meeting, Tokyo, 6 June 2019.
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June 6, 2019 Bank of Japan How Finance and ICT Combine: a Historical View on the Future Keynote Speech at the Institute of International Finance (IIF) Spring Membership Meeting Haruhiko Kuroda Governor of the Bank of Japan I. Introduction Good afternoon. It is a great pleasure to welcome you all. Let me thank Chairman Weber, President Adams and the IIF Team for organizing this conference. Looking back, the first IIF G20 conference was convened in London in early March 2009, when the global financial system remained under severe stress. One topic discussed at the conference was the role of the international financial institutions, including the Asian Development Bank I was leading at that time, in mobilizing liquidity for emerging market and developing countries. A month later, when the G20 leaders met in London and agreed to strengthen financial regulation to rebuild trust, they also agreed to increase very substantially the resources and enhance the tools available through these institutions to support the continued flow of capital to these countries. That agreement was proved to be vital in fighting the crisis. With the assistance of the institutions, emerging market and developing countries were largely successful in avoiding the contagion of the crisis and their strong growth supported world growth. Following the tradition of the first and of subsequent conferences, I hope that this conference will also provide additional impetus for cooperation in order to pursue our G20 Agenda. Reflecting the upcoming G20 Agenda, tomorrow's morning sessions will focus on the future of finance and the role of financial regulation and supervision against the backdrop of the rapid evolution in information and communications technology (ICT). Today, I would like to share my thoughts on this topic. Throughout history, finance and ICT have interacted and evolved closely together. Also throughout history, people have found ways to overcome the resultant challenges and have realized the opportunities. I believe we are at that point of challenge and opportunity now. Let me start by looking back at some key historical episodes because I think they are telling. II. Historical Episodes of the Interaction between Finance and ICT Finance enables money to travel from one person's pocket to another's across time and space. It reallocates resource, diversifies risk, and provides means for settlement. Throughout history, people have developed financial technologies to make use of the state of the art ICTs available at that time, in pursuit of defying the gravity that constrains the dynamic and cooperative use of available resources. The earliest writing system known as cuneiform script was invented by the Sumerians of Mesopotamia about 5,000 years ago and can be seen as our first example of the interaction between the evolution in finance and ICT. Scholars believe that the genesis of cuneiform writing is to be found in accounting. 1 Three-dimensional tokens whose shapes -- cones and spheres -- represented a specific amount of goods were used for trade. The tokens then developed into two-dimensional clay tablets with pictographs. As the size of cities grew and society became more complicated, the clay tablets experienced a significant innovation. They incorporated an abstract number system, which allowed significant abstraction of data that could be communicated using the same size of tablets. It is probable that writing was further developed by the emerging need for debt contracts. Evolution in finance and ICT closely interacted in Sumerian cities. Our next example, the invention of the printing press in the 15 th century by Johannes Gutenberg, had a long-lasting effect in promoting the interaction between the evolution in finance and ICT on a global scale. One major impact of the new printing process was to diffuse knowledge in finance. For example, in Venice in 1494, mathematician Luca Pacioli, a friend of Leonardo da Vinci, published a book which included short yet comprehensive instruction on the principle of double-entry bookkeeping. From Venice, then the world's printing center, Pacioli's instruction, its commentaries, and applied examples disseminated one of the most fundamental principles in finance throughout Europe and the world. And what about other major impacts of the new printing process on economic growth? Did the diffusion of the printing press have significant impact on aggregate productivity? In general, measuring the impact of ICT on aggregate productivity is a challenging task for For details, see Denise Schmandt-Besserat, How Writing Came About (Austin: University of Texas Press, 1996). economists and policymakers as Robert Solow wrote of a later time, "you can see the computer age everywhere but in the productivity statistics."2 But recently, LSE economist Jeremiah Dittmar has provided evidence showing how the printing press did indeed contribute to productivity in certain cities.3 He has shown that cities where printing presses were established in the 15th century experienced an accelerated economic growth. And it was in the Netherlands that cities adopted the printing press faster than in most other countries and these Dutch cities went on to accumulate great wealth. This wealth was a necessary underpinning for exploration to Asia. But exploration also required wider access to capital. By the mid-17th century, the city of Amsterdam had risen to be the center of international finance and trade, the cradle of modern financial architecture. In Amsterdam were the first public company with limited liabilities, the first stock exchange, and one of the ancestors of the modern central bank. And one more key interaction between the ICT and finance: the printing press assisted newspapers to become an important route of transmission for the timely distribution of the information necessary for active trading of shares and many commodities.4 This, in turn, further widened access to capital. These innovations were embodied in the rise of the Dutch East-India Company. Starting in 1602, the Company's share was traded freely on the city's first stock exchange and later, limited liability was admitted for major shareholders. Combining ample capital with advanced maritime technologies, the Company expanded its business throughout Asia. Robert M. Solow, "We'd Better Watch Out," New York Times Book Review July 12 (1987). For Japan's study, see Takuji Fueki and Takuji Kawamoto, "Does Information Technology Raise Japan's Productivity?," Japan and the World Economy vol. 21, no. 4 (2009): 325-336; and for the U.S.'s study, see Robert J. Gordon, The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War (Princeton: Princeton University Press, 2016). Jeremiah E. Dittmar, "Information Technology and Economic Change: The Impact of the Printing Press," Quarterly Journal of Economics vol. 126, no. 3 (2011): 1133-1172. For details, see Peter Burke, A Social History of Knowledge: From Gutenberg to Diderot (Polity, 2000). There is another story. The Company was particularly important for Japan because it was the only Western organization allowed to operate under the Tokugawa Shogunate's national seclusion policy. The Company's sole trading post was confined in a fan-shaped, man-made island called "Dejima" in the bay of Nagasaki. The island, which was only the size of two football pitches, functioned as a solitary yet robust information hub to maintain the flow of ideas between Japan and the West for more than 200 years. People in Japan studied imported books and digested technologies from the West. Employees of the Company wrote books on what they learned in Japan. Harnessing the very latest ICT -- the printing press, the newspapers -- people in the Dutch cities of the Golden Age were able to find the opportunities of financial innovations. III. Market Failures and the Role of Financial Regulation and Supervision Financial innovations also held dangers. Now, let me turn to the risk of financial innovations. Historically, the wider access to capital through markets also became important sources of economic volatility. In 1776, Adam Smith warned that company managers exempt from being liable for company losses were the managers of "other people's money". He believed that these managers could not apply the "anxious vigilance" that partners with unlimited liabilities would apply. He concluded that, "negligence and profusion, therefore, must always prevail". His warning was proven to be significant. Today, the principal-agent problem he raised stands as one of the key market failures that justify public interventions for private companies. Problems of limited liability are especially significant for financials since asymmetric information is more likely to exacerbate the magnitude of the problems. For example, under limited liability, investment managers would benefit from bubble blowing, but not necessarily suffer a symmetrical loss when it bursts. Some economists show that a combination of limited liability and asymmetric information among market participants can incentivize the investment managers to blow the bubble.5 Although the evolution in ICT has For example, see Franklin Allen and Gary Gorton, "Churning Bubbles," Review of Economic Studies vol. 60, no. 4 (1993): 813-836; and Franklin Allen and Douglas Gale, "Bubbles and Crises," Economic Journal vol. 110, no. 460 (2000): 236-255. contributed to developments in modern financial risk management technologies, such developments, even combined with enhanced disclosure, have not eradicated the problems. Next year 2020 will mark the three-hundredth year of the bursts of the first internationally-correlated financial bubbles. In 1720, the burst of the South Sea Bubble in London, the bubble which inspired Adam Smith, was accompanied by a similar crash in Paris, known as the Mississippi Bubble. In the aftermath, people lost their trust in capital markets and the creation and trading of joint stock companies were sharply curtailed for a century. Stagnation of capital markets left large investment projects predominantly financed by a small group of rich people.6 Financial bubbles tend to associate with financial crises when accompanied by excessive credit creation. Economists who look into long-term cross-country data find that credit growth is indeed a powerful predictor of financial crises.7 Financial crisis entails significant negative externalities to the economy. Our experience of Japan's crisis in the late 1990s and of the last global financial crisis in the late 2000s reminds us that the most important role of financial regulation and supervision is to address market failures in order to prevent financial crises. The G20 financial reforms launched in 2009 to address the fault lines revealed by that crisis are nearly complete. The reason for seeking global cooperation through international negotiation is to realize the mutual benefits in addressing the risk of globalized financial activities. Throughout the process of international negotiation, different cultures as well as different social and economic systems make contact with each other. I was involved in a number of negotiations and saw these differences surface in a myriad ways. Negotiators tend to feel For details, see William N. Goetzmann, Money Changes Everything: How Finance Made Civilization Possible (Princeton: Princeton University Press, 2016). Moritz Schularick and Alan M. Taylor, "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review vol. 102, no. 2 (2012): 1029-1061. uneasy when the differences require alternative ways of thinking, which is an important aspect of international cooperation. In order to establish the common rules which are mutually beneficial to all relevant parties in the global markets, it is helpful to view the differences as dynamic and relative in nature and to accept the differences. Now that the regulatory reform agenda is nearly complete, we must turn our focus onto the full, timely, and consistent implementation of the agreed reform in order to achieve the goal of maintaining global financial stability. At the same time, it is important to evaluate the effects of the agreed G20 reforms to assess whether reforms are operating as intended. And essentially we must identify and address possible sources of market fragmentation that may be harmful to global financial stability. IV. Concluding Remarks Let me finally add a few words on how I view the future of finance and the role of financial regulation and supervision against the backdrop of the current rapid evolution in ICT. Even though the Sumerian clay tablets of 5,000 years ago have today been substituted by tablet PCs and smartphones, the central role of finance to enable money to travel from one person's pocket to another's across time and space remains unchanged. That said, the amount of information that can be communicated using tablet PCs and smartphones today is incomparably greater than using clay tablets. Our current evolution in ICT is paving the way for ever-growing digitalized information to be swiftly collected, processed and communicated at ever-decreasing cost across space. The new ICTs have the potential to provide not only economies of scale but also economies of scope and hence give market power to those who successfully apply those technologies. As we learned from Dutch history, the future shape of the financial industry will be significantly influenced by the contemporary evolution in ICT, although it may be difficult to predict today what the future shape of the industry will be. This afternoon, we talked about how banks could harness the power of technology to drive sustainable growth. Tomorrow, we will talk about how the financial sector will need to continue evolving to serve a transforming society. We will also talk about the implications of the evolution on the role of financial regulation and supervision. On the opportunities side, the evolution will open up immense possibilities for many individuals and firms to carry out a wide range of financial transactions across time and space. For example, it has strong potential to promote financial inclusion. A World Bank report finds that 69 percent of adults had an account at a bank or mobile money provider in 2017, up from just 51 percent in 2011. It also reports that globally 1.7 billion adults remain unbanked, yet two-thirds of them own a mobile phone that could help them access financial services.8 A joint report from the Center of Financial Inclusion at Accion and the IIF shows that the market for inclusive insurance is also vast and potentially profitable, based on the confluence of rising income in emerging markets and ICT that is bringing down the cost of distributing insurance and measuring risks.9 On the challenges side, the degree of market failures could be magnified by our current evolution in ICT. We hear concerned voices that the current evolution could lead to concentration of data and resources in a small number of economic agents. The economies of scale and scope derived from the new ICTs could encourage greater reliance of core banking services on globally concentrated third-parties. This, in turn, could seriously complicate the existing principal-agent problem and magnify market failures. Although the key role of financial regulation and supervision remains unchanged, we should leverage innovative technology in financial supervision. And we should continue to monitor and assess the impact of evolving market structures and of the evolution in ICT on the nature of the market failures that need to be addressed by financial regulation and supervision. Let me wrap up. I see our current evolution in ICT as having strong potential to magnify both the opportunities and the risks of finance. We face a difficult yet rewarding challenge to control and limit the downside while encouraging the upside of the evolution. History tells us that we can find ways to overcome the challenges and realize the opportunities. Is this time any different? I believe not. Since the global financial crisis, our framework of international Asli Demirgüç-Kunt et al., "The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution," World Bank Group (2018). Susy Cheston et al., "Inclusive Insurance: Closing the Protection Gap for Emerging Customers," A Joint Report from the Center for Financial Inclusion at Accion and the Institute of International Finance (2018). cooperation among authorities and market participants has significantly strengthened. Through our critical discussions and cooperation, I believe together we shall overcome the new challenges and unleash our potential opportunities. Thank you.
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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, Shizuoka, 30 May 2019.
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the G20 High-Level Symposium on Aging and Financial Inclusion (GPFI Forum), Tokyo, 7 June 2019.
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June 7, 2019 Bank of Japan Financial Inclusion in an Aging Society Keynote Speech at the G20 High-Level Symposium on Aging and Financial Inclusion (GPFI Forum) in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor for me to speak at the G20 High-Level Symposium on Aging and Financial Inclusion (GPFI Forum) today.1 This year, I co-chair the G20 Finance Ministers and Central Bank Governors Meetings with Minister Aso. One of the priorities for G20 Finance Track in 2019 is "aging and its policy implications," and this is related to the theme of today's forum, "Aging and Financial Inclusion." I trust the outcome of this symposium will contribute significantly to the discussions at the G20 meetings. Japan is one of the most aged countries in the world. Sooner or later, other countries will face a similar situation. Today, I would like to talk about the current situation in Japan and the challenges it faces, focusing on financial inclusion in an aging society, with respect to personal finance and financial literacy in particular. I. Aging Society and Financial Literacy Japan's average life expectancy in 2017 was 81 years for men and 87 years for women. Over the past 50 years, longevity has risen dramatically, by 13 years for men and 14 years for women. Aging itself is something to be welcomed in that people have always wished for a longer life. Meanwhile, issues surrounding the aging society have been brought into the spotlight. From a financial perspective, household finance management after retirement is particularly important. How to make ends meet in later life is an issue many people face. In terms of personal finance, in Japan, public pensions are generally the main source of income after retirement. However, given life's uncertainties, public pensions alone may not always be sufficient. When expenditure exceeds income, people commonly offset the gap by withdrawing the financial assets they had been saving until then. Global Partnership for Financial Inclusion (GPFI) is an inclusive platform for all G20 countries, interested non-G20 countries, and relevant stakeholders to carry forward work on financial inclusion, including implementation of the G20 Financial Inclusion Action Plan, endorsed at the G20 Summit in Seoul in 2010. . According to a survey conducted in 2018 by the Central Council for Financial Services Information (CCFSI) in Japan, the average amount outstanding of financial products held by households with two or more people was 14.3 million yen.2 Looking at the results by age, the amount outstanding held by those in their twenties was about 2.5 million yen, while for those in their sixties, the figure was about 18.5 million yen. It could be said that, overall, senior citizens in Japan already hold a substantial amount of financial assets. Nevertheless, people in their sixties need to learn how to extend the life of the assets they have accumulated, especially as they can now expect to live another 20 to 30 years, or even more as we look ahead to a normal life span of 100 years. Meanwhile, for the younger generation, it is important to accumulate assets steadily over time, as they look forward to living a long life. On this point, long-term personal asset formation finds policy support in Japan through the expansion of tax benefit systems. One example is Japan's individual savings account for the long-term, diversified, and periodic investment of a small fixed amount with tax exemption, or the Tsumitate NISA. Another example is individual-type defined contribution private pension plan with various tax benefits, or the iDeCo. As life expectancy increases, people need to find ways to extend the life of their financial assets. This means that everyone has to plan for their lives after retirement and acquire financial literacy -- that is, to obtain the knowledge necessary to manage their money effectively. The importance of financial education was discussed at the G20 Los Cabos Summit in 2012, and was emphasized in the Leaders Declaration.3 In relation to financial education, I would like to briefly touch upon the aforementioned CCFSI. The CCFSI has its secretariat at the head office of the Bank of Japan. It promotes the advancement of financial knowledge under the following two principles: to provide financial and economic information, and to disseminate pecuniary education. It has a nation-wide network with local committees in all 47 prefectures in Japan. In cooperation with the head office, branches, and local offices of the Bank of Japan, as well as the government, local public bodies, private entities, and others, the CCFSI works to enhance citizens' financial literacy from a neutral and fair position. CCFSI, Survey of Household Finances, November 2018 (available only in Japanese). G20, G20 Leaders Declaration, June 2012. II. Financial Inclusion for Senior Citizens Next, I would like to elaborate on financial inclusion for senior citizens. The concept of financial inclusion holds that no one should be left behind in having access to and benefiting from financial services. This is closely related to the United Nations' Sustainable Development Goals (SDGs).4 As we get older, we all become physically weaker. Declining mobility means we can no longer take it for granted that we can easily visit bank branches. Deteriorating eyesight and hearing ability may impair our capacity to fill out a form or understand a face-to-face explanation. Declining cognitive ability may create difficulty in making financial decisions. Moreover, there is the risk that senior citizens will become victims of financial crime. In 2018, among all recorded cases of so-called special fraud in Japan -- such as telephone-based identity deception -- 78 percent of the victims were aged 65 and over.5 Financial inclusion is therefore an extremely important social agenda in an aging society, as it ensures that senior citizens -- who may have difficulty in visiting banks or making financial transactions due to age-related decline -- can continue to use financial services with confidence and benefit as much as possible from these services. In the field of what is known as "financial gerontology," there has been discussion about ways to make the adult guardianship system more effective in order to protect the rights of senior citizens with cognitive decline. The use of innovative digital technologies has also been considered. For example, using biometric technology for identity verification and mobile payments will enable senior citizens to have secured access to financial services without actually visiting bank premises. Moreover, the use of speech recognition technology will enable financial transactions to be made without the need for physical writing or keyboard skills. Advances The SDGs are global development goals set by the United Nations in 2015. They are made up of 17 goals with 169 associated targets to be achieved by 2030. 5 See the National Police Agency, Situation of Special Fraud Cases Known to the Police and of Those Cleared Up for 2018 (Provisional Values) (available only in Japanese), February 2019. Special fraud refers to a type of fraud or extortion offense in which the offender deceives their victim, over the phone or by other means, such as into transferring money to a designated account. For reference, the total amount outstanding of loss arising from special fraud for 2018 is reported to be 35.68 billion yen. in technology may create increasingly comprehensive financial services that are better tailored to the needs of the individual senior citizen. These new financial services for senior citizens can also be a great business opportunity for financial institutions. On the other hand, as technology advances, the risk of technology abuse will increase, and vigilance is therefore essential to maintain security. I will be following with great interest how technological innovations in finance -- so-called fintech -will contribute to financial inclusion for senior citizens. Concluding Remarks One realistic option to ensure a comfortable living in later life is to continue working as long as possible.6 Professor Lynda Gratton,7 who is here today as a speaker in the next session, argues that we can now look forward to a 100-year life, living and working much longer. In such a society, the idea of a traditional three-stage work-life model -- first education, then work, and finally retirement -- will become outdated, and a multi-stage model -- undergoing many life and career transitions -- will become the new standard. In this regard, the Japanese government is promoting working-style reforms that also take longevity into consideration. In light of these changes and challenges, the Bank of Japan is working to support the development of sound financial services by, for example, improving financial literacy through the activities of the CCFSI, and promoting fintech, so that everyone can use financial services with confidence, even in an aging society. Thank you for your kind attention. According to the Annual Report on the Ageing Society: 2018 released by the Cabinet Office, about 40 percent of working people aged 60 or over answered that they would like to work "till anytime as long as I can work." When adding those who answered they would like to work "till almost 70," "till almost 75," and "till almost 80," about 80 percent of the respondents were very eager to work even in their old age. 7 Professor of Management Practice at London Business School. Co-author of: Lynda Gratton and Andrew Scott, "The 100-Year Life -- Living and Working in an Age of Longevity." (London: Bloomsbury Publishing, 2016).
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Closing remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the G20 High-level Seminar on Financial Innovation, Fukuoka, 8 June 2019.
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Haruhiko Kuroda: Our future in the digital age Closing remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the G20 High-level Seminar on Financial Innovation, Fukuoka, 8 June 2019. * * * I am delighted to be given this opportunity to speak to you at the end of this important seminar. Today, we discussed two topics on the theme of “Our Future in the Digital Age.” The first session explored potential benefits and risks arising from financial and technological innovation. As a key to achieving a better society, speakers highlighted the importance of leveraging emerging digital technology in financial services. At the same time, they also pointed out the build-up of risks in the financial and economic system. The second session examined blockchain technology. The panel laid out key factors to facilitate a sound expansion of decentralized financial ecosystems. Ongoing financial innovation is anticipated to further impact the financial and economic system. Although it is difficult to predict the outcomes, we can learn from the progress and issues arising from financial innovation in the past decades. For example, credit and market risk management tools along with risk transfer technology enhanced financial intermediation. On the other hand, however, the global financial crisis was partly attributable to such progress in technology, which is still fresh in our minds. How then can we mitigate risks while benefiting from innovative technology? A good clue to that would be to interpret financial and economic activities as interactions within a system as well as among multiple systems. Examples include portfolio insurance strategies on Black Monday, which led to an unexpectedly sharp drop in equity prices through interactions among market participants. The recent financial crisis displayed a feedback loop between deteriorated liquidity in securitization markets and severe funding conditions in the banking sector. Historically, the financial system has carried risk-amplifying mechanisms in an insidious manner that would pose serious threats to the system as a whole. People realized their mistakes only after unexpected disasters took place. The modern financial system has repeated such experiences. Innovative financial services and new entrants have begun to transform the structure of the financial system. We should reap the benefits of innovation while carefully assessing risks that build up unintentionally. Recent innovation also provides us with policy tools to address these issues. Incorporating big data into analytics reveals how individual market transactions and payment flows make up the entire financial network. Evolution in computing capacity and computational technology has brought changes to existing analytical approaches, which requires the simplification of the financial and economic system for applying theoretical models. Emerging technology allows us to observe details and model the system as it really is, helping assess interactions among firms, individuals, and market participants. Technology that deals with unstructured data, including text, images, and audio, has evolved quite rapidly. It could also be applied to broader areas, such as the analysis of market sentiments and expectation formation. Paradoxically, the more technology evolves, the more human aspects draw attention. These are closely linked to the actions of individuals and institutions. A deeper understanding of micro behaviors would help us better predict macro-economic and financial outcomes. I hope this G20 high-level seminar has provided you valuable insights to shape the future of the digital age. Thank you for your attention. 1/2 BIS central bankers' speeches 2/2 BIS central bankers' speeches
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Speech by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Aomori, 27 June 2019.
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June 27, 2019 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Aomori Masazumi Wakatabe Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Good morning. It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Aomori Prefecture. This is my first meeting of this kind since the start of the Reiwa era. Aomori Prefecture is blessed with a rich natural environment such as the Shirakami Mountains, which are registered as a World Heritage site, Lake Towada, and the Hakkoda Mountains. It has a long history represented by a Jomon clay figurine designated as a national treasure, as well as the Sannai-Maruyama Site. It also is an area distinguished by a rich culture that has produced many intellectuals and artists, such as Shoeki Ando (philosopher), Osamu Dazai (novelist), Shuji Terayama (poet and playwright), and Noriko Awaya (singer). The Bank of Japan's Aomori Branch was established in 1946. I heard that, due to a shortage of materials at the time, there were great difficulties in constructing the branch building. Since then, the branch has operated to the present owing to support from people in the region. I would like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the branch. Today, I would like to hear your views on the current status of the local economy, as well as your candid opinions about the Bank's policies and activities. First, I will briefly explain developments in Japan's economic activity, and then talk about the Bank's conduct of monetary policy, regional financial institutions in Japan, and economic developments in Aomori Prefecture. I. Economic Developments A. Economic Improvement since 2013 First, I would like to take a look at how Japan's economy has changed under quantitative and qualitative monetary easing (QQE) that the Bank introduced in April 2013. Looking back, Japan's economy suffered a significant downturn due to the Global Financial Crisis in 2008, and thereafter remained below the pre-crisis level until around 2012. In contrast, since 2013, it has followed an improving trend under the Bank's monetary easing, albeit with fluctuations (Chart 1). Domestic demand such as private consumption and business fixed investment has been increasing more considerably than the previous recovery phase of around 2002-2008, despite slower growth in external demand (Chart 2). This suggests that, even amid a weaker tailwind from overseas, well-balanced economic growth has materialized as domestic demand has been stimulated strongly, partly by various policy measures. The well-balanced growth of Japan's economy since 2013 also can be evidenced by an improvement in the employment and income situation. Labor market conditions have continued to tighten steadily in Japan, with the active job openings-to-applicants ratio rising to the level seen in the 1970s and the unemployment rate declining to the level observed in the early 1990s (Chart 3). A notable feature of such improvement is a substantial increase in the numbers of employed persons and employees. This shows that tight labor market conditions in the current phase are attributable to an increase in labor demand, rather than to a decrease in labor supply that results from a decline in the working-age population. If labor market conditions had tightened, due mainly to a decline in labor supply, the number of employees would have declined since the number of those who wish to work would decrease with wages unchanged and the labor supply curve would shift to the left (Chart 4).1 In reality, the number of employees has continued to increase, along with a moderate rise in wages, and therefore employee income has continued to register relatively high growth. Such improvement in the employment and income situation, together with generally favorable corporate profits, has supported solid domestic demand. B. Effects of the Monetary Easing I think that the Bank's monetary easing has contributed greatly to achieving economic growth, in which domestic and external demand have increased in a well-balanced manner Compared to the fact that the numbers of employed persons and employees have increased significantly since 2013, wage increases have been relatively weak. This suggests that the labor supply curve could have shifted to the right -- the direction indicating that the labor supply has increased. Although the continued decline in the working-age population aged 15-64 can contribute to shifting the labor supply curve to the left, there is a possibility that mainly women and seniors have become more willing to work, due to the progress in labor market reform that enabled various working styles, the extension of healthy life expectancy, and the rise in expectations that labor market conditions will remain tight. Firms seem to be addressing demographic changes including the declining birthrate and aging population proactively by, for example, taking various steps to secure their labor force and expanding labor-saving investment, rather than merely considering these changes as constraints. accompanied by the improvement in the employment and income situation. In what follows, I will explain the effects of the monetary easing since 2013, by describing changes in financial conditions and its impact on economic and price developments. Let me start with the changes in financial conditions. Since the introduction of QQE in 2013, Japan's interest rates have declined significantly. The decline in interest rates has stimulated the private sector's credit demand and improved financial institutions' lending attitudes. These have resulted in a clear increase in the amount outstanding of funding in the private sector (Chart 5). There is considerable evidence that the financing environment for firms has improved considerably under the monetary easing. I will move on to the effects of the monetary easing on economic activity and prices. It can be said that it has led to an upturn in the economic and price situation by, for example, producing accommodative financial conditions and influencing people's expectations, as well as through a resultant rise in asset prices. Since the actual economic and price conditions are subject to various factors, it is not easy to quantify the effects of the monetary easing alone. That being said, let me introduce one simulation of how economic activity and prices would have developed since 2013 if the Bank's QQE had not been introduced (Chart 6). Although the estimation results should be interpreted with a certain latitude, this analysis suggests that (1) QQE has strongly stimulated economic activity and prices through, for example, a decline in interest rates, and (2) without QQE, it is highly likely that the current situation where Japan's economy is no longer in deflation could not have been achieved amid a continuous shortage in demand.2 The simulation shown in Chart 6 is based on a vector auto-regressive (VAR) model consisting of the following variables: the monetary base, interest rates for different maturities, the output gap, the consumer price index (CPI) excluding fresh food and energy, and the foreign exchange rate. The future path of the output gap and the CPI was simulated assuming that there had not been any shocks on interest rates or the monetary base. The results are generally consistent with those presented in the Bank's Comprehensive Assessment released in September 2016, which estimated the effects of QQE on economic and price developments based on a large-scale semi-structural model of Japan's economy. The effects of the monetary easing are exerted so indirectly through mainly interest rates that people cannot feel them easily. However, I would like to emphasize that the monetary easing in fact has been underpinning the economy firmly from various aspects as I explained earlier. C. Current Situation and Outlook for Japan's Economy I have described so far that Japan's economy has been on an improving trend since 2013 under the Bank's monetary easing. However, exports and production have been relatively weak since early this year amid growing concern about deceleration in overseas economies (Chart 7). On this point, the Bank currently assesses that Japan's economy has maintained its moderate expanding trend, although exports and production have been affected by the slowdown in overseas economies. The monetary easing has been sustaining steady domestic demand. Also, as for the outlook, the main scenario is that the economy is likely to continue expanding moderately as a trend, with the growth rates of overseas economies rising somewhat and domestic demand maintaining its firmness (Chart 8). More recently, however, further attention needs to be paid to downside risks to the main scenario. The latest economic outlooks by international organizations such as the International Monetary Fund (IMF) also have pointed out that, although the global economic growth rate is projected to increase somewhat from the second half of 2019, this scenario entails substantial uncertainties. Most notably, the trade friction between the United States and China involves significant issues beyond mere economic problems -such as the competition in advanced technologies and national security -- and it may be difficult to resolve these issues fundamentally in a short period of time. The negotiation between the two countries is still underway, so we should not be too pessimistic. If the trade friction becomes prolonged or persistent, however, downward pressure on the global economy may heighten not only through the direct effects of the tariff hikes but also deterioration in firms' fixed investment stance and financial market sentiment.3 In Europe, uncertainties over political developments including negotiations on the United Kingdom's exit from the European Union (EU) remain high, and in the Middle East, for example, geopolitical risks warrant careful attention. If the slowdown in overseas economies becomes prolonged, downward pressure on domestic demand may strengthen gradually. In addition, there remains a risk that the scheduled consumption tax hike this October may push down domestic demand and eventually economic activity and prices. II. Conduct of Monetary Policy A. Why Is the Price Stability Target of 2 Percent Necessary? Next, I will talk about our conduct of monetary policy. The Bank has conducted monetary easing policy with a view to achieving the price stability target of 2 percent. At my previous meeting with business leaders held in Niigata last December, I elaborated on why the Bank has set the price stability target at 2 percent.4 Setting the target level at 2 percent is a global standard; if we lowered the target, deflationary pressure would be exerted through changes in people's expectations as well as in foreign exchange rates and asset prices. In addition, the Bank does not consider it sufficient if only prices go up; rather, it thinks that achieving the 2 percent target contributes to the sound development of the national economy -- for example, increases in nominal GDP, corporate profits, household income, and the number of employees, as well as fiscal soundness. A rise in labor costs has been pointed out in recent years as one of the factors behind price rises. Labor costs are, in other words, wages and salaries. Increases in wages and salaries will lead to price rises, but it also is true that According to the G-20 Surveillance Note written by IMF staff this June, it is estimated that global GDP is likely to be lower by 0.5 percent in 2020, taking into account the impact of an increase in tariffs on 200 billion dollars' worth of United States imports from China from 10 percent to 25 percent, the possible 25 percent tariff on the roughly 267 billion dollars' worth of United States imports from China, and the tariff hikes already conducted in 2018. For details, see https://www.imf.org/external/np/g20/pdf/2019/060519.pdf. Masazumi Wakatabe, "Japan's Economy and Monetary Policy," speech at a meeting with business leaders in Niigata, December 5, 2018, http://www.boj.or.jp/en/announcements/press/koen_2018/data /ko181205a1.pdf. firms are not able to raise wages and salaries in a situation where they cannot increase the prices of their products and services. In this speech, I would like to explain the Bank's monetary policy from a somewhat different perspective. The Reiwa era has just started. Most of the Heisei era, which lasted from January 1989 to April 2019, was one of deflation, and marked by a battle against it. Unfortunately, economic activity also stagnated during that period. While there have been various views to explain what caused deflation, we have to note with the utmost seriousness that only Japan fell into prolonged deflation among advanced economies, the rest of which achieved inflation of around 2 percent for most of the time.5 However, under the Bank's price stability target of 2 percent, Japan's economy is no longer in deflation. Since the introduction of QQE in April 2013 in particular, the inflation rate on average has increased from around 0.5 percent in negative territory to around 0.5 percent in positive territory. This improvement was achieved under the Bank's clear commitment to the 2 percent target and the monetary easing pursued in line with it (Chart 9). B. Cause of Low Interest Rates: Decline in the Natural Rate of Interest That being said, the inflation rate has not yet reached 2 percent, being in the range of 0.5-1.0 percent when excluding fresh food, and therefore the Bank's monetary easing has continued for a long period of time. In this situation, there are requests for higher interest rates. Some may think that the Bank can raise interest rates because it can control them as it wants. But the reality is not that simple.6 Kataoka Goushi, Nihon no "Ushinawareta 20-nen": Defure o koeru keizai seisaku ni mukete (Tokyo: Fujiwara-Shoten, 2010); Masazumi Wakatabe, Japan's Great Stagnation and Abenomics: Lessons for the World (New York: Palgrave Macmillan, 2015); Takenaka Heizo, Heisei no kyōkun: Kaikaku to gusaku no 30-nen (Tokyo: PHP Institute, Inc., 2019); and Iwata Kikuo, Naze defure o hōchi shite wa ikenai ka: Hitode busoku keizai de yomigaeru Abenomikusu (Tokyo: PHP Institute, Inc., 2019). For one example as an answer to the same question in the United States, see Stanley Fischer, "Why Are Interest Rates So Low? Causes and Implications," remarks at the Economic Club of New York, October 17, 2016, https://www.federalreserve.gov/newsevents/speech/fischer20161017a.htm. Why have interest rates remained low in the first place? Interest rates are low not only in Japan but in other advanced economies. In economics, it is said that if you want to raise a rate, cut it first; if you want to cut a rate, raise it first. A central bank lowers interest rates when the economy slips into a downturn with a higher risk of deflation. Then, as the inflation rate goes up, reflecting the economic recovery, a central bank raises interest rates accordingly. Let me elaborate on this. Monetary policy today is based on the following understanding. The level of the interest rate that balances savings and investment and neither accelerates nor decelerates the economy is called the natural rate of interest, or the equilibrium real interest rate. A central bank conducts monetary policy using the natural rate of interest as a reference point. Specifically, at a time of an economic downturn, a central bank stimulates the economy by guiding the actual interest rate to a level below the natural rate of interest. When the economy is overheated, a central bank raises the interest rate to a level above the natural rate of interest. As the natural rate of interest is just an estimate based on a theoretical model and entails uncertainties, it should be interpreted with a certain latitude.7 With this in mind, I would say that the natural rates of interest have declined in many advanced economies including Japan (Chart 10). In the case of Japan, the natural rate of interest declined sharply in the early 1990s. In other advanced economies, the rates have decreased since the Global Financial Crisis. This suggests that the natural rates of interest have been affected by the bubble burst as well as financial and economic crises. Generally speaking, the reason behind a decline in the natural rate of interest is one of the following: an increase in savings, a decrease in Jerome H. Powell, "Monetary Policy in a Changing Economy," speech at a symposium titled "Changing Market Structure and Implications for Monetary Policy" held in Jackson Hole sponsored by the Federal Reserve Bank of Kansas City, August 24, 2018, https://www.federalreserve.gov /newsevents/speech/powell20180824a.htm; and Richard H. Clarida, "Models, Markets, and Monetary Policy," speech at the Hoover Institution Monetary Policy Conference titled "Strategies for Monetary Policy" held at Stanford University, May 3, 2019, https://www.federalreserve.gov /newsevents/speech/clarida20190503a.htm. investment, or a combination of these two. For example, when households and firms seek to increase their savings in the event of an economic crisis, the supply of funds in the economy will increase and the natural rate of interest will decline. If growth expectations deteriorate due partly to an economic crisis or a decrease in productivity, and thereby firms become less willing to make investment, actual investment will decrease and the natural rate of interest consequently will decline. Demographic changes such as the declining birthrate and aging population also are pointed out as causes of the decline in the natural rate of interest.8 Moreover, some say that a global saving glut plays a major role and others point to the possibility of "secular stagnation."9 In a case where the natural rate of interest declines for any reason, a central bank needs to lower interest rates accordingly because otherwise the economy will be under deflationary pressure. In Japan, short-term nominal interest rates already have reached close to 0 percent since the 1990s. In light of this situation, the Bank has taken such measures as (1) lowering long-term interest rates through purchases of Japanese government bonds (JGBs), introducing a negative interest rate policy to guide short-term nominal interest rates to negative territory, (3) adopting an inflation-overshooting commitment, under which 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, and The following study examines the effects of demographic changes on the natural rate of interest. Assuming that a decline in labor force lowers the economic growth rate and that the extension of longevity results in an increase in savings, this study estimates that about 270 basis points can be attributed to demographic changes out of the 640 basis points decline in real interest rates over the past 50 years in Japan. Nao Sudo and Yasutaka Takizuka, "Population Aging and the Real Interest Rate in the Last and Next 50 Years: A Tale Told by an Overlapping Generations Model," Bank of Japan Working Paper Series, no.18-E-1, January 2018, https://www.boj.or.jp/en/research/wps_rev /wps_2018/data/wp18e01.pdf. However, attention should be paid to the fact that the study does not take into account the effects of financial crises as factors causing a decline in the natural rate of interest. Secular stagnation refers to a situation where aggregate demand in an economy remains below its potential supply capacity for a long time, resulting in a further decline in the capacity. For more details on the decline in the natural rate of interest and secular stagnation, see a collection of papers by Lawrence H. Summers, Ben S. Bernanke, Paul Krugman, and Alvin H. Hansen in Keiki no kaifuku ga kanjirarenai no wa nazeka: Chōki teitai ronsō, ed. and trans. Hiroo Yamagata (Kyoto: Sekaishisosha Co., Ltd., 2019), available only in Japanese. introducing forward guidance stating that the Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time. Once an economy falls into deflation, households and firms will strengthen their expectations that deflation may continue. Especially when deflation lasts for a long time as in Japan, such expectations will heighten further. In that case, firms and households will perceive interest rates as higher than the actually low level of nominal interest rates. We call such perceived interest rates, which take into account inflation expectations, real interest rates. The Bank's price stability target of 2 percent is expected to encourage firms and households to strongly hold expectations that prices will rise steadily, resulting in a decline in real interest rates. The word "normalization" is often used with regard to monetary policy, but it is an ambiguous term with an unclear definition. The ultimate objective of monetary policy is the sound development of the national economy. In other words, it is not until the economic and price situation is normalized that monetary policy also will be normalized.10 The Bank will continue with the monetary easing for as long as it is necessary to achieve the price stability target of 2 percent in a sustainable manner. C. Discussions over the Monetary Policy Framework Amid low interest rates and low inflation observed globally, central banks and academics have had discussions that mainly regard the monetary policy framework. The Bank of Canada reviews its monetary policy framework every five years; the Federal Reserve Arguments for raising interest rates include the "theory of ammunition." According to this, a central bank should raise interest rates in advance -- as if loading a gun with ammunition -- because otherwise it cannot lower interest rates when the next economic downturn occurs. Of course, when the price stability target is achieved in a sustainable manner, interest rates are likely to increase reflecting inflation. However, interest rate hikes before the price stability target is achieved will instead bring about an economic downturn, which will be counterproductive. recently has discussed whether to update its framework.11 Key points of such discussions including these can be summarized as the following.12 First, through the experience of Japan's battle against deflation and the U.S. and European economies following the Global Financial Crisis, policy tools such as QQE, a negative interest rate policy, and forward guidance have been added to the central banks' "arsenal." They will be used going forward depending on the situation. Second, the inflation target framework has been proved effective even in the time of the Global Financial Crisis and its aftermath, but it has been pointed out that, even in the United States, where economic and price developments are relatively firm, interest rates have remained lower and room for monetary policy response has become smaller than before. Under these circumstances, there are ongoing debates in the United States and other economies on what monetary policy framework should be adopted with a view to achieving the medium- to long-term price stability. Various approaches have been proposed, such as setting a higher inflation target and introducing average inflation targeting, price-level targeting, the inflation target range, and nominal GDP targeting (Chart 11). Every approach has its own advantages and challenges. Of course, Japan cannot be treated the same as other economies such as the United States, where the inflation rate is already at around 2 percent. The Bank judges at present that it is appropriate to maintain the current policy framework in which it clearly commits to the price stability target of 2 percent and pursues the monetary easing to achieve the target. That being said, I think it is necessary for the Bank to work sufficiently on studies toward better monetary policy. Regarding the Bank of Canada's review of its monetary policy framework to date, see https://www.bankofcanada.ca/agreement-inflation-control-target/. As for the Fed Listens events that the Federal Reserve has proceeded with, see https://www.federalreserve.gov/monetarypolicy /review-of-monetary-policy-strategy-tools-and-communications-fed-listens-events.htm. With regard to the challenges of and outlook for monetary policy at present, the following paper by Ben S. Bernanke, former Chair of the Federal Reserve, is informative. See Ben S. Bernanke, "Monetary Policy in a New Era," in Evolution or Revolution? Rethinking Macroeconomic Policy after the Great Recession, ed. Olivier Blanchard and Lawrence H. Summers (Cambridge: The MIT Press, 2019), pp.3-48. III. Regional Financial Institutions in Japan Next, I would like to talk about regional financial institutions in Japan. Needless to say, they play an extremely useful role in regional economies. With accommodative monetary policy lasting for a long period of time, the challenges faced by the regional financial institutions in Japan and the impact of such monetary policy on them have come to draw attention. Japan's financial system can be characterized as follows. First, indirect financing has been dominant. Indirect financing is a form of finance in which depositary financial institutions such as banks play a significant role in firms' funding. Second, particularly in regional financial institutions, the ratio of deposits to overall financial liabilities is high while that of corporate bonds and equities is low. Third, regional financial institutions in particular depend on deposit-taking and lending activities. However, financial institutions, not only in regions but in Japan as a whole, are now entering a phase of drastic changes. Structural changes are taking place, such as the declining population and aging, globalization, as well as technological innovation evidenced by new entries to the settlement business from outside the financial sector. National accounts data show that the corporate sector has become a net lender of funds since the mid-1990s (Chart 12). This also is related to the decline in the natural rate of interest that I mentioned earlier. Even among small and medium-sized firms, the ratio of the so-called de facto debt-free firms -- defined as firms with cash and deposits that exceed their total amount of borrowings -- has continued to increase, recently exceeding 40 percent.13 Structural factors such as these lie behind the decline in financial institutions' profits. Interest rates used to be high worldwide, reflecting high inflation and high natural rates of interest. However, unfortunately, it is unlikely for such an environment to be realized again soon. At regional financial institutions, although net income has remained high in the long run, pre-provision net revenue (PPNR) has continued to follow a declining trend. The Financial System Report released this April shows profit simulation for the next 10 years. The results suggest that more than half of domestic regional banks are expected to run According to Teikoku Databank. deficits in 10 years if the borrowing demand of the corporate sector continues to decline at the same pace as in the past. Of course, it should be noted that these results need to be interpreted with a latitude as they are calculated based on certain assumptions (Chart 13). Here, it is worth referring to the case of financial institutions in Europe, where a negative interest rate policy has been introduced, as in Japan. The Financial System Report compares financial institutions in Europe with those in Japan. Under a negative interest rate policy, the former have made higher profits than the latter. This is partly because funding costs of financial institutions in Europe have decreased against the background that the low interest rate environment has lasted for a shorter period than in Japan, and therefore there has been room for a further decline in deposit interest rates. Also, in Europe, the share of deposit funding to overall financial liabilities is low, and the costs of market financing such as issuing corporate bonds have been declining. Moreover, financial institutions in Europe have secured various sources of revenue that are unsusceptible to changes in interest rates by, for example, diversifying fees on services (Chart 14). For higher profitability going forward, it is hoped that regional financial institutions will set lending rates that reflect risks appropriately, (2) depart from excessive dependence on deposit-taking and lending activities by, for example, increasing fee-based income, and drastically improve their business efficiency. 14 To push forward with these initiatives strongly and effectively, the use of digital technology, integration or partnering among financial institutions, and alliances with firms outside the financial industry can be effective options. The Bank will continue to support these efforts by financial institutions. IV. Economic Developments in Aomori Prefecture Now, I would like to talk about the economy of Aomori Prefecture. Looking at current developments, economic activity in Aomori Prefecture has been on a moderate recovery For discussions based on the comparison of financial institutions in Japan with those overseas, see Hiroshi Nakaso, "New Frontier of Macroprudential Policy: Addressing Financial Institutions' Low Profitability and Intensified Competition," speech at the Kin'yu Konwa Kai (Financial Discussion Meeting) hosted by the Jiji Press, November 29, 2017, http://www.boj.or.jp/en/announcements /press/koen_2017/ko171129a.htm/. trend, albeit at a slower pace. The production growth has decelerated, reflecting weaker overseas demand. Business sentiment of primarily manufacturing firms has become cautious, and thus business fixed investment has been more or less flat. Meanwhile, labor market conditions have continued to tighten, and private consumption has maintained its recovery trend with employee income improving. Let me touch on the economic structure of the prefecture. The prefecture has experienced a continued decline in population for 20 years longer than Japan overall and faced shrinking internal demand. During this time, it has taken initiatives such as inviting firms and managed to maintain its economic scale by attracting demand from other prefectures -mainly the Tokyo metropolitan area -- and from overseas. It does not seem easy, however, to keep its economic scale going forward as the population already has started to decrease across the country. That being said, I also have felt during this visit that the prefecture has many advantages in terms of overcoming the challenges. Also, it is not constructive to only focus on the negative side of the declining population. Declining birthrates and aging populations are now advancing worldwide. As I mentioned earlier, Japan's economy has continued to improve moderately since 2013 despite a prolonged declining trend in population. Even though the population continues to decrease, we can prepare countermeasures if we factor that in beforehand. As aging population has progressed, the healthy life expectancy has become longer. As evidenced by the fact that drones and artificial intelligence (AI) already have started to be used in agriculture here, the declining population can promote innovation.15 For example, Aomori Prefecture has abundant resources, such as one of the largest agriculture, forestry, and fishery industries in Japan, manufacturing firms of worldwide prominence, as well as a natural environment and culture that attract attention from all over At the G20 Symposium co-hosted by the Bank of Japan and the Ministry of Finance on January 17, 2019, the theme of the discussion was "demographic changes and macroeconomic challenges." In the session, Toshitaka Sekine, Director General of the Research and Statistics Department at the Bank of Japan, discussed the extension of healthy life expectancy accompanied by that of longevity, and Yasuyuki Sawada, Chief Economist of the Asian Development Bank (ADB), discussed the possibility of the declining population promoting innovation. For more information, see https://www.g20fukuoka2019.mof.go.jp/en/meetings/20190117.html. the world. As a big fan of Jomon culture, I feel very encouraged to hear about the efforts to register Jomon Archaeological Sites on the World Cultural Heritage List. I met people working on vitalizing the local economy by making the most of these advantages. In addition, Aomori Prefecture has diverse cultures, history, and economic structures, depending on the area. To make use of such diversity, I hope that not only existing firms will make active efforts, but also startups aiming at achieving new growth will be provided with coordinated support by the industries, the administration, academics and research institutions, as well as financial institutions. Such initiatives are expected to help the prefecture make further progress toward its goal of realizing a self-sustaining economy. As the central bank of Japan, we also will support the local economy by, for example, analyzing the situation and disseminating information through the Aomori Branch. I would like to ask for your continued cooperation regarding the activities of the branch going forward. Conclusion Mitsuru Yoshida, known as the author of Senkan Yamato no saigo (Requiem for Battleship Yamato), once worked as General Manager of the Bank's Aomori Branch from 1965 through 1968. Yoshida, who was very fond of Aomori Prefecture, placed high expectations on its potential, saying that Aomori could be the Norway of Japan, and that Aomori was a "future prefecture."16 He also stated that, if all the potential could be exploited, there would be a bright future ahead, and that we could not just keep waiting to firmly grasp those big dreams in our hands. These words apply not only to Aomori Prefecture but also to Japan's economy as a whole. As I already mentioned, most of the Heisei era was one of deflation, and marked by a battle against it. Unfortunately, Japan's economy stagnated in that deflationary era. While other advanced economies achieved inflation of around 2 percent, we have to take seriously the fact that only Japan fell into deflation for a long period. As price stability is stipulated as the principle of the policy conduct in the Bank of Japan Act, the Bank has a responsibility to Yoshida's essays on Aomori Prefecture were first compiled in Aomori sanka (Aomori: To-o Nippo Press Co., Ltd., 1967), and are now included in Yoshida Mitsuru Chosakushū, vol. 2 (Tokyo: Bungeishunju Ltd., 1986). avoid deflation.17 The Bank will firmly pursue policy conduct so that the economy will never fall into deflation in the new Reiwa era. Thank you very much for your attention. "The responsibility for deflation basically lies in monetary policy. This is because central banks are obliged to avoid deflation or inflation and stabilize prices." See Haruhiko Kuroda, Zaisei kin'yū seisaku no seikō to shippai (Tokyo: Nippon Hyōron sha Co., Ltd., 2005), p.182. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Aomori 㻌 2019 June 27, 㻌 MasazumiWakatabe Deputy Governor of the Bank of Japan Chart 1 Japan's Economy Nominal GDP Real GDP s.a., ann., tril. yen s.a., ann., tril. yen Introduction of QQE Introduction of QQE CY00 Source: Cabinet Office. CY00 Chart 2 Exports and Domestic Demand Real Exports Domestic Demand s.a., CY 2015=100 108 s.a., CY 2011=100 Consumption Activity Index (travel balance adjusted, real, left scale) Private nonresidential investment (SNA, real, right scale) s.a., ann., tril. yen CY03 CY03 Note: In the right chart, figures for the Consumption Activity Index (travel balance adjusted) exclude inbound tourism consumption and include outbound tourism consumption. Sources: Ministry of Finance; Cabinet Office; Bank of Japan, etc. Chart 3 Labor Market Tightening Active Job Openings-to-Applicants Ratio and Unemployment Rate s.a., % s.a., ratio Unemployment rate (left scale) Working-Age Population and Number of Employed Persons 2.0 s.a., mil. persons Introduction of QQE 1.8 Active job openingsto-applicants ratio (right scale) mil. persons 1.6 1.4 1.2 1.0 0.8 0.6 CY 65 0.4 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. CY 03 Number of employed persons (left scale) Working-age <aged 15-64> population (right scale) Chart 4 Mechanism of Labor Market Tightening Increase in Labor Demand Decrease in Labor Supply Wages Wages Labor supply curve Labor supply curve Up Up Labor demand curve Labor demand curve Decrease Increase Quantity of Labor Quantity of Labor Chart 5 Effects of QQE: Financial Conditions Amount Outstanding of Private-Sector Funding Lending Attitudes of Financial Institutions as Perceived by Firms DI ("accommodative" - "severe"), % points Introduction of QQE Introduction of QQE tril. yen -10 Large enterprises -20 Small enterprises -30 CY 95 CY10 Notes: 1. In the left chart, figures are based on the Tankan. All industries. There is a discontinuity in the data in December 2003 due to a change in the survey framework. Notes: 2. The right chart shows the sum of loans (domestic private banks and shinkin banks), CP, and corporate bonds. Loans outstanding among domestic private banks are adjusted for Notes: 2. special items, such as the foreign exchange rates. Sources: Japan Securities Depository Center; I-N Information Systems; Bank of Japan, etc. Chart 6 Effects of QQE: Economic Activity and Prices Consumer Price Index Output Gap % y/y % chg. Actual (less fresh food and energy) Without QQE Actual Without QQE -1 -2 -3 Simulation -4 -1 -5 Simulation -6 -7 CY01 -2 CY 01 Note: For details of the simulation, see footnote 2 in the main text. Sources: Bloomberg; Ministry of Internal Affairs and Communications; Bank of Japan, etc. Chart 7 Recent Developments in Overseas Economies and Japan's Production World Trade Volume and Global Manufacturing PMI y/y % chg. Japan's Industrial Production s.a., DI. s.a., CY2015=100 World trade volume (left scale) -2 Global manufacturing PMI (right scale) -4 CY 12 CY12 Note: In the left chart, figures for the trade volume are those for real imports. Figures for the global manufacturing PMI are the "J.P. Morgan Global Manufacturing PMI." Sources: CPB Netherlands Bureau for Economic Policy Analysis; IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.); Ministry of Economy, Trade and Industry. Chart 8 Outlook for Economic Activity BOJ's Forecasts of Real GDP IMF Projections for Major Economies (as of April 2019) (April 2019 Outlook Report) y/y % chg., % points World Advanced economies 3.8 3.6 2.4 2.2 2.2 United States 2.4 Euro area Japan Emerging market and developing economies Projection 2.9 1.8 1.9 0.8 4.8 4.5 China 6.8 6.6 ASEAN-5 5.4 5.2 Latin America and the Caribbean 1.2 1.0 s.a., ann., tril. yen Fiscal 2021 㸩1.2㸣 Projection 3.3 3.6 (-0.2) (0.0) 1.8 1.7 (-0.2) (0.0) 2.3 1.9 (-0.2) (0.1) 1.3 1.5 (-0.3) (-0.2) 1.0 0.5 (-0.1) (0.0) 4.4 4.8 (-0.1) (-0.1) 6.3 6.1 (0.1) (-0.1) 5.1 5.2 (0.0) (0.0) 1.4 2.4 (-0.6) (-0.1) Fiscal 2020 㸩0.9㸣 Fiscal 2019 㸩0.8㸣 FY 12 Notes: 1. In the left chart, figures in parentheses show the differences from the January 2019 projections. Notes: 2. In the right chart, forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: IMF; Cabinet Office; Bank of Japan. Chart 9 Consumer Prices y/y % chg. -1 -2 CPI (all items less fresh food) CPI (all items less fresh food and energy) -3 CY 85 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Average from 2013/Q2 to 2019/Q2 + 0.5% CPI (all items less fresh food and energy) Average from 2000/Q1 to 2013/Q1 - 0.5% Chart 10 Natural Rates of Interest % U.S. Canada Euro area U.K. Japan -1 -2 CY 80 Sources: Kathryn Holston, Thomas Laubach, and John C. Williams, "Measuring the Natural Rate of Interest: International Trends and Determinants," Journal of International Economics, 2017, 108, S59-S75; Yosuke Okazaki and Nao Sudo, "Natural Rate of Interest in Japan: Measuring Its Size and Identifying Drivers Based on a DSGE Model," Bank of Japan Working Paper Series, no.18-E-6, 2018. Chart 11 Discussions over the Monetary Policy Framework Overseas Proposals Description Higher Inflation Target … raise the target [from 2 percent] to, say, 3 or 4 percent (Bernanke, 2017) Average Inflation Targeting … targeting average inflation over a multiyear period (Clarida, 2019) Price-Level Targeting … [targeting] the level of prices on a steady growth path, rising by (say) 2 percent per year (Bernanke, 2017) Temporary Price-Level Targeting … apply a price-level target … only to periods around ZLB episodes, retaining … the current 2 percent [inflation] target at other times (Bernanke, 2017) Inflation Target Range … [setting a] goal within that range …, perhaps year by year, depending on specific economic circumstances (Rosengren, 2018) Nominal GDP Targeting … targeting the growth rate or the level of nominal GDP (Svensson, 2019) Sources: Ben S. Bernanke, "Temporary Price-Level Targeting: An Alternative Framework for Monetary Policy," The Brookings Institution, October 12, 2017, https://www.brookings.edu/blog/ben-bernanke/2017/10/12/temporary-price-level-targeting-an-alternative-framework-for-monetary-policy/; Richard H. Clarida, "The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices," remarks at the 2019 U.S. Monetary Policy Forum, February 22, 2019; Eric S. Rosengren, "Considering Alternative Monetary Policy Frameworks: An Inflation Range with an Adjustable Inflation Target," speech at the Money, Models, & Digital Innovation Conference, January 12, 2018; and Lars E.O. Svensson, "Monetary Policy Strategies for the Federal Reserve," prepared for a presentation at the Conference on Monetary Policy Strategy, Tools, and Communication Practices at the Federal Reserve Bank of Chicago, June 5, 2019. Chart 12 Saving-Investment Balance of the Private Corporate Sector tril. yen ↑ Net savings -20 ↓ Net investments -40 -60 FY 80 Note: Private non-financial corporations. Source: Bank of Japan. Chart 13 Simulation of Medium- to Long-Term Bank Profits Net Income ROA Share of Banks with Net Losses [Domestic Regional Banks] [Domestic Regional Banks] % 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 FY 06 Simulation % Simulation Decreasing loan demand case Constant loan demand case FY 06 [Domestic Shinkin Banks] [Domestic Shinkin Banks] % 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 FY 06 Simulation % Simulation Source: Bank of Japan. FY06 Chart 14 Comparison with Negative Policy Rate Countries Factors in their Changes Gross Operating Profit ROAs 3.5 % 1.6 Japan Euro area Switzerland Sweden 1.2 Net non-interest income 0.8 Interest payments on corporate bonds, borrowings, etc. 0.4 Interest payments on deposits 3.0 2.5 chg. from FY2011 to 2017, % points 0.0 2.0 -0.4 -0.8 1.5 -1.2 1.0 FY11 Interest income on loans Interest income on securities, etc. Gross operating profit ROAs -1.6 Japan Euro area Switzerland Note: Gross operating profits of Japanese banks include realized gains/losses on stockholdings to make them comparable with those of banks in other countries. Sources: S&P Global Market Intelligence; Bank of Japan. Sweden
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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, Hiroshima, 3 July 2019.
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Yukitoshi Funo: Economic activity, prices, and monetary policy in Japan Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hiroshima, 3 July 2019. * * * I. Recent Economic and Price Developments A. Overseas Developments I would like to begin by talking about overseas economies, which have been growing moderately on the whole, although slowdowns have been observed. Uncertainty regarding the outlook has been heightening, due in part to protectionist moves, but private consumption has been firm on the whole, partly supported by a favorable employment and income situation. In terms of the outlook, slowdowns are likely to continue for the time being; thereafter, however, overseas economies are expected to grow moderately on the whole with their growth rates rising somewhat. Looking at developments by major region, the U.S. economy has been expanding moderately, whereas the European economy has been decelerating. The Chinese economy has continued to see stable growth on the whole, but some weakness has been observed in the manufacturing sector. Other emerging and commodity-exporting economies have been recovering moderately on the whole, mainly on the back of the effects of those economies’ stimulus measures. As for the outlook, the U.S. economy is expected to maintain its moderate expansion and the European economy is projected to gradually move out of its deceleration phase. The Chinese economy is likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policies in a timely manner. Other emerging and commodity-exporting economies are likely to continue to see moderate recovery on the whole. Risk factors to the overseas economic outlook are wide ranging and likely to be significant, as exemplified by (1) the U.S. macroeconomic policies and their impact on global financial markets, (2) the consequences of protectionist moves, including those observed in U.S.-China trade negotiations and their effects, (3) developments in emerging and commodity-exporting economies, (4) the progress in global adjustments in IT-related goods, (5) negotiations on the United Kingdom’s exit from the European Union (EU) and their effects, and (6) geopolitical risks. As it can be said that there is uncertainty surrounding overseas economies, it is necessary to stay vigilant regarding these risk factors, including their impact on firms’ and households’ sentiment in Japan. B. Japan’s Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan. The economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports and production have been affected by the slowdown in overseas economies. It has continued to grow at a pace above its potential growth rate.1 This is evidenced by the real GDP growth rate having registered 1.8 percent for the October-December quarter of 2018 on an annualized quarter-onquarter basis, and 2.2 percent for the January-March quarter of 2019. According to the Bank of Japan’s June 2019 Tankan (Short-Term Economic Survey of Enterprises in Japan) released at the beginning of July, the diffusion index (DI) for business conditions for all industries and enterprises has remained positive despite being affected by the slowdown in overseas economies and other factors. 1/5 BIS central bankers' speeches Meanwhile, after enduring the severe damage caused by the heavy rain, which mainly affected western Japan in July 2018, Hiroshima Prefecture has seen steady progress in its restoration and reconstruction, owing to the efforts of those involved. To give an example, although firms’ production activities had become stagnant due to damage to production facilities, a water cutoff, and disruptions to traffic infrastructure, these effects have more or less dissipated. Moreover, such inviting locations as the two World Heritage Sites of Hiroshima — the Atomic Bomb Dome and the Itsukushima Shrine — as well as the beauty of the archipelago in the Setouchi region are attracting tourists from home and abroad once again, making up for the past slowdown. With regard to the outlook, Japan’s economy is likely to continue growing at about the same pace as its potential on average and continue on an expanding trend, despite being affected by the slowdown in overseas economies for the time being.2 Specifically, for now, exports are projected to show some weakness and business fixed investment also is likely to decelerate somewhat, reflecting the effects of the slowdown in overseas economies. Meanwhile, private consumption is expected to continue increasing as the employment and income situation continues to improve. Thereafter, Japan’s exports are projected to return to their moderate increasing trend, with overseas economies expected to grow moderately on the whole. 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, mainly against the background of highly accommodative financial conditions and the underpinnings through government spending, despite being affected by such factors as the scheduled consumption tax hike. In terms of specific figures for the economic growth rate, as provided in the April 2019 Outlook for Economic Activity and Prices (Outlook Report) released by the Bank, the medians of the Policy Board members’ forecasts are 0.8 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.2 percent for fiscal 2021. 1. Under a specific methodology, Japan’s potential growth rate is estimated to be in the range of 0.5-1.0 percent recently. 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. 2. It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to food and beverages — excluding alcohol and dining out — and newspapers. 2. Prices Let me now explain price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is in the range of 0.5-1.0 percent and at around 0.5 percent excluding the effects of energy prices, together suggesting that it has continued to show relatively weak developments compared to the economic expansion and labor market tightening. With regard to the outlook, medium- to long-term inflation expectations are projected to rise gradually as firms’ stance is likely to gradually shift toward further raising wages and prices with the output gap remaining positive. As a result, the year-on-year rate of change in the CPI (all items less fresh food) is likely to increase gradually over time. In terms of specific figures, the medians of the Policy Board members’ forecasts of the year-on-year rate of change presented in the April 2019 Outlook Report are 1.1 percent for fiscal 2019, 1.4 percent for fiscal 2020, and 1.6 percent for fiscal 2021.3 1. 3The forecasts assume the following: (1) the consumption tax will be raised to 10 percent in October 2019 and a reduced tax rate will be applied to food and beverages — excluding alcohol and dining out — and newspapers, and (2) with regard to policies concerning the provision of free education, measures for free early childhood education as well as other measures including free higher education will be introduced in October 2019 and April 2020, respectively. 2/5 BIS central bankers' speeches II. Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I would like to discuss several points that I think deserve particular attention in terms of realizing the outlook for economic activity and prices that I mentioned earlier. A. Employment and Income Situation Let me first talk about the employment and income situation. As the economy has continued its moderate expansion, the output gap has remained clearly positive, and supply-demand conditions in the labor market have continued to tighten steadily. The Labour Force Surveybased number of employees has continued to increase firmly when smoothing out fluctuations, and the active job openings-to-applicants ratio has been at a high level that exceeds the peak marked during the bubble period. In addition, the unemployment rate has remained at a low level. These indicators of supply-demand conditions in the labor market show that the degree of labor market tightness has been at the level last seen in the first half of the 1990s or in the first half of the 1970s. Amid such supply-demand conditions in the labor market, the latest rate of base pay increase for fiscal 2019 is about the same as the actual rate for fiscal 2018. The year-on-year rate of increase in scheduled cash earnings of full-time employees is in the range of 0.5-1.0 percent. In addition, that in hourly scheduled cash earnings of part-time employees, which are responsive to supplydemand conditions in the labor market, has registered relatively high growth at around 2 percent. As a result, although total cash earnings per employee have been increasing moderately, albeit with fluctuations, the increases have remained relatively weak compared to the labor market tightening, partly due to the high wage elasticity of labor supply in recent years, mainly among women and seniors. As Japan’s economy is likely to continue on an expanding trend, it is expected that the number of employees will keep increasing and supply-demand conditions in the labor market will continue to tighten steadily. I therefore expect the rate of increase in total cash earnings per employee to gradually accelerate. B. Prices Next, I will turn to price developments, taking into account the employment and income situation. The year-on-year rate of change in the CPI (all items less fresh food and energy) has remained at around 0.5 percent. The relatively weak developments compared to such factors as the labor market tightening are attributable to the mindset and behavior based on the assumption that wages and prices will not increase easily, which have been deeply entrenched among firms and households, due mainly to the experience of prolonged low growth and deflation. In addition, room for raising productivity and progress in information technology in recent years, for example, have allowed firms to absorb an increase in costs and thereby maintain their cautious stance toward raising prices. While affected by various factors, I view the underlying trend in prices as being determined by the aggregate supply-demand balance. In other words, a positive output gap leads to a rise in the inflation rate through a virtuous cycle from income to spending. In the case of households, for example, a tightening of labor market conditions encourages an increase in private consumption through a rise in wages, thereby leading to an increase in the year-on-year rate of change in the CPI. In this regard, 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 been rising on average recently. In this situation, I believe various changes are spreading throughout the economy. For example, in terms of private consumption, firms have developed and supplied new products to tap potential demand in view of the increasing variation in consumer needs. My impression is that 3/5 BIS central bankers' speeches consumers, in response, are tolerant of the prices set for products and services that are not necessarily inexpensive, as long as they are unique and have high value-added, like travel packages that offer a new life experience in return. As for the outlook, it is projected that, with the output gap remaining positive, firms’ stance gradually will shift toward further raising wages and households’ tolerance of price rises will increase. In this situation, further price rises are likely to be observed widely and medium- to long-term inflation expectations are projected to rise gradually. As a consequence, it can be said that the year-on-year rate of change in the CPI is likely to increase gradually. Conversely, attention should be paid to the fact that a change in the mindset and behavior of firms and households does not occur overnight and may in fact take a considerable amount of time. III. Conduct of Monetary Policy Let me now turn to the Bank’s monetary policy. The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and has been conducting monetary policy to achieve this target at the earliest possible time. To this end, the Bank has been pursuing powerful monetary easing, considering developments in economic activity and prices, as well as financial conditions, under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control. The Bank, under this framework, has been conducting yield curve control, in which it controls shortand long-term interest rates. Specifically, at present, according to the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. By conducting this operation, short- and long-term interest rates have been stable at low levels, and I consider that the highly accommodative financial conditions, brought about by yield curve control, have stimulated firms’ and households’ spending activities. Meanwhile, prices have continued to show relatively weak developments compared to the economic expansion and labor market tightening, with Policy Board members’ forecasts presented in the April 2019 Outlook Report indicating that it likely would still take time to achieve the price stability target. As part of its efforts to do so, at the Monetary Policy Meeting (MPM) held on April 24 and 25, the Bank decided to clarify forward guidance for policy rates. Specifically, the description of the existing guidance was partially revised, thereby making clear that the Bank would “maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike.” By doing so, the Bank clarified its unchanged policy stance to persistently continue with the current powerful monetary easing. What I would like to call attention to here is that the current extremely low levels of short- and long-term interest rates will be maintained “for an extended period of time” and that the inclusion of “at least” in the description regarding the time frame of the guidance indicates a fair possibility that the current low interest rates will be maintained beyond “around spring 2020.” In other words, “for an extended period of time” does not denote “through around spring 2020"; rather, it implies an open-ended period even beyond that. The Bank also decided at the April MPM to implement measures contributing to the continuation of powerful monetary easing. Specifically, the Bank decided to (1) expand the scope of eligible collateral for its provision of credit for such purposes as the Bank’s lending to financial institutions, (2) improve the use of the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, (3) relax the terms and conditions for the facility of temporarily lending Japanese government securities (JGSs) held by the Bank, and (4) consider introducing an exchange-traded fund (ETF) lending facility, which would make it possible to lend its ETFs to market participants. These measures are aimed at strengthening policy durability in 4/5 BIS central bankers' speeches order for the Bank to continue with powerful monetary easing through its smooth fundprovisioning and securing of market functioning. Given the current situation, where prices and inflation expectations have not risen easily, it is necessary to maintain a positive output gap for as long as possible by keeping interest rates at sufficiently low levels for a prolonged time, in order to achieve the price stability target. I believe that the clarification of forward guidance and the aforementioned four measures will bolster confidence in the Bank’s continuation of powerful monetary easing and further ensure achievement of the price stability target. With a view to achieving the target, the Bank will continue conducting monetary policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. IV. Challenges for Japan’s Economy I now would like to express my thoughts regarding the current situation for Japan’s economy from a longer-term perspective. According to the Bank’s estimates, the potential growth rate has been in the range of 0.5-1.0 percent recently. Although the rate has risen compared to around 2010, it can be said that Japan’s growth potential has been sluggish. This is also an indication of the various challenges that Japan faces in achieving a rise in productivity. With regard to corporate activities, for example, firms’ utilization of resources to achieve the intended goals should be minimized, and the achievement process needs to be managed by means of effective corporate governance. Unless this way of thinking is widely accepted by firms, however, excessive resources — including labor — tend to be allocated in order to produce results that are more impressive than necessary, regardless of the marginal benefit. This tendency, prevalent across professions and industries, seemingly is encouraged by Japan’s employment practices and bottom-up approach to management. In spite of these trends, going forward, I see the potential growth rate rising through an improvement in productivity as a wide range of entities continue with initiatives concerning structural reforms and growth strategies. Take recent developments for instance; namely, the output gap being positive and labor market conditions remaining considerably tight, as evidenced by the existing labor shortage. Such underlying developments seem to have given rise to changes in employment practices, including increased mobility in the labor market brought about by the efficient allocation of excess labor resources from sectors with low productivity to those with high productivity. Alongside this, progress in working-style reforms and other initiatives suggests a deepening awareness among both workers and managers of the need to raise productivity. Pursuing structural reforms and growth strategies is not an easy task and a fairly extensive process. Nonetheless, it is safe to say that the necessary conditions for a rise in productivity, which will bring about a boost in Japan’s growth potential, gradually are being fulfilled. I believe these developments will play a role in underpinning the virtuous cycle from income to spending. Specifically, a rise in productivity will act as a starting point of such cycle, stimulating price rises through increases in wages and private consumption. Effects of monetary policy are not directly transmitted to economic entities — namely, individual firms and households — and thus may take time to materialize in the form of backing up their efforts. However, they should be able to support various initiatives as the Bank’s conduct of monetary policy stimulates aggregate demand and suitably tight supply-demand conditions are maintained. Therefore, with a view to achieving its price stability target and realizing sustainable economic growth in a coordinated manner, the Bank needs to persistently continue with its powerful monetary easing and consistently provide support for the initiatives of a wide range of economic entities. 5/5 BIS central bankers' speeches
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bank of japan
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a Reuters Newsmaker Event, Tokyo, 5 July 2019.
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July 5, 2019 Bank of Japan Should the Bank of Japan Issue a Digital Currency? Speech at a Reuters Newsmaker Event in Tokyo Masayoshi Amamiya Deputy Governor of the Bank of Japan (English translation based on the Japanese original) I. Introduction It is a great honor and pleasure for me to be able to speak to you today. In recent years, the environment surrounding Japan's payment and settlement systems has gone through various changes. On the demand side, consumers seek more convenient payment services, such as those available during the nighttime and on holidays or low-cost international remittance services. Diversified lifestyles and the spread of e-commerce businesses have contributed to this. On the supply side, new devices -- such as smartphones and IC cards -- enabling the public to access payment services have continued to expand. In addition to traditional financial institutions, non-bank firms with strong capabilities in information technologies, or so-called FinTech firms, have started to provide cashless payments services. As central banks have a responsibility to improve the safety and efficiency of payment and settlement systems, their future landscape in the digital age is an extremely important topic for us. In fact, whether central banks should issue digital currencies as a payment instrument substituting for cash (banknotes and coins) has become an important issue. Digital currencies issued by central banks are called "central bank digital currencies" (CBDCs). The Bank for International Settlements (BIS) conducted an interesting survey on central bank initiatives for CBDC (Figure 1). Among the 63 respondent central banks, about 70 percent are engaged in CBDC work, most of which is in the form of research/study or experiments/proof-of-concept. Central banks that have actually been developing CBDCs and are seriously considering its issuance are in the minority; they are limited only to those of countries, such as Sweden where the circulation of banknotes is rapidly decreasing and emerging and developing countries where the infrastructure supporting banknotes has not yet fully developed. Except for these cases, many central banks see themselves as unlikely to issue CBDCs in the short or medium term. Many central banks therefore take the position that they have no plan to issue CBDCs in the near future but will continue research into CBDCs, which is the position the Bank of Japan also takes. But why do central banks take this seemingly contradictory position? The main aim of this speech is to explain the background to this. First allow me to outline Japan's current status regarding retail payments -- that is, developments in person-to-person (P2P) money transfers and person-to-merchant (P2M) payments -- and then talk about the possible forms of CBDC and its expected roles. I will then discuss the implications of the research on CBDC for the future payment and settlement systems as a whole, including private digital currency. II. Cash and Cashless Payments in Japan Let's start by looking at survey results and statistics to discover current trends in retail payments and the degree of progress toward a cashless society in Japan. Payment Instruments for Individuals According to the results of a recent survey on individuals' payment instruments, the ratio of cash payments to cashless payments in private consumption expenditure is almost one to one (Figure 2). This figure displays the survey results of the share of payment instruments. In the survey, transfers between bank accounts are included as cashless payments. Thus, it should be noted that the ratio of cashless payments is at a higher level compared with that excluding transfers between bank accounts, which is often the case in other surveys. Looking at the share of payment instruments, the share of credit cards is high, at about 30 percent, and that of prepaid electronic money issued by firms such as transport and distribution firms is about 5 percent. The use of FinTech payment services, or "XYZ pay," that use mobile devices such as smartphones is still very limited, accounting for less than 1 percent. At what pace will the share of cashless payments increase? It is difficult to project the pace but developments in the amount of cash in circulation are useful as reference information (Figure 3). The year-on-year rate of change in the amount of cash in circulation for 1 yen and 5 yen coins for 2018 declined very moderately. Meanwhile, the rate for the 100 yen coin was in the range of 0.5-1.0 percent, increasing at around the same rate as the nominal GDP growth rate for 2018. The rates for the 500 yen coin and 1,000 yen banknote were over 2 percent. Those for 10,000 yen and 5,000 yen banknotes were even higher, being in the range of 3 to 4 percent. This increase in the amount of high denomination banknotes in circulation, including 10,000 yen banknotes, reflects the increasing demand for cash as a store of value -- that is, savings held in the form of cash under the mattress. The lower interest rate environment has lowered opportunity cost of holding cash. On the contrary, not many people hold 1,000 yen banknotes or 500 yen coins, or even 100 yen coins, under the mattress. I think the increase in circulation of these banknotes and coins indicates the possibility of their continued use as a means of payment rather than as a store of value. Based on these facts, cashless payments seem to be expanding in small-value payments where the change piles up, but cash still continues to be widely used as a means of payment. The year 2018 saw a growing social interest in cashless payments; however, despite the general impression gained from the media, the pace of transition from cash to cashless payments seems to have been moderate. The news that there were long queues at bank ATMs before the 10-day holiday from late April to early May 2019 indicates that cash is still an important payment instrument for many consumers. Moderate Transition to Cashless Payments Why the moderate transition to cashless payments in Japan? It is considered that the causes lie in both the demand and supply of cash payments. The demand for cash payments is thought to be related to people's perception of cash: less concern about wasting money than when using cashless payment instruments; a safe environment where cash is rarely stolen and is even often returned when people lose their pocketbooks or purses; and public confidence in the high anti-counterfeit security levels of Japanese banknotes, resulting in counterfeit banknotes having a very low circulation. The prolonged low interest rate environment may also have pushed up the demand for cash. As for the supply of cash payments, cash payment networks supported by financial institutions' bricks and mortar branches and ATMs are important (Figure 4). The denser the networks, the more convenient cash withdrawal from the bank account and cash deposit to the account. For this reason, the greater the number of branches of financial institutions per habitable area, the higher the ratio of cash in circulation to nominal GDP tends to be. Japan's high ratio of cash in circulation to nominal GDP is considered to be due to the established convenient and inexpensive cash supply chain, as exemplified in the concentration of financial institutions' branches and ATMs within a small national territory. These structural factors in the demand and supply of cash payments are considered to have slowed down the transition to the cashless payments. Nonetheless, if the number of new cashless payments users and merchants increases up to a certain scale, the use of cashless payments could then expand sharply. Let's take a look at the case of South Korea. In the wake of the Asian currency crisis in the late 1990s, South Korea's government promoted cashless payments as a part of economic policy package. It introduced a system of a deduction of 20 percent of annual credit card payments from taxable income, and obliged merchants to accept credit cards. These measures turned the tide, and the move toward a cashless society accelerated. In Japan as well, the government plans to introduce loyalty rewards for using cashless payment instruments with the scheduled consumption tax hike in October 2019. These measures may provide a boost toward the cashless society in Japan. III. Central Bank Digital Currency and Private Digital Currency The phenomenon of the demand for cash being surprisingly persistent and the ratio of cash in circulation to nominal GDP continuing to increase has been observed not only in Japan but in many countries.1 Nonetheless, cashless payments will likely increase in numerous countries in the long run. Against this background, there has been a growing interest in the digitization of currencies issued by central banks, or central bank money. Morten L. Bech et al., "Payments Are A-Changin' But Cash Still Rules," BIS Quarterly Review, March 2018. 1. Issuance Forms of Central Bank Digital Currency There are two main variants of CBDC. One variant is electronic central bank money, which offers access to a limited group of users such as banks, among whom it is used for funds settlement. This variant, called "wholesale CBDC," adopts new information technologies such as distributed ledger technology (DLT) in settlements using central bank deposits, or central bank liabilities which have been digitized. The other variant is electronic central bank money which is assumed to be widely accessible, including for individuals and firms. This variant is called "general purpose CBDC." From now on, I will use the term CBDC to refer to the general purpose variant. A general purpose CBDC is a substitute for cash (banknotes and coins), and two issuing forms are possible (Figure 5). One is an "account-based" CBDC, in which individuals and firms open an account at a central bank and use it to make transfers between accounts. This scheme is fundamentally the same as transfers between accounts held at private banks. The difference lies in whether the accounts are held at the central bank or at private banks. The other form is a "token-based" CBDC, also referred to as a "value-based" CBDC, in which users deposit CBDC to their smartphone applications or IC cards and transfer value to other users when making payments. This scheme is similar to prepaid electronic money issued by transport and distribution firms and FinTech firms. The difference is whether the issuer is a private firm or the central bank. 2. Expected Roles for Central Bank Digital Currency CBDCs are expected to play various roles (Figure 6). For instance, in terms of monetary policy, academia, in principle, argues that CBDCs should bear interest -- even negative interest rates in some cases -- as that could increase the effectiveness of monetary policy. This argument is based on the premise that the level of interest rates applied to CBDC could work as the effective lower bound of interest rates for wide-ranging financial assets. However, in order to overcome the zero lower bound of nominal interest rates, cash needs to be completely eliminated. This is because even if a central bank applies negative interest rates to CBDC, as long as cash which yields zero interest remains, there will be a shift of funds toward cash. Abolishing cash, used by many people, would only make payment infrastructures less convenient. There is no central bank that wishes to do this. Resolving the Crowding of Cashless Payment Instruments We often hear the opinion that the rationale for issuing CBDC is to resolve the crowding of cashless payment instruments and to unify all payment instruments. Because of the large number of cashless payment instruments currently available, consumers are often at a loss as to which one to use. In this regard, Professor Sheena Iyengar of Columbia University conducted an interesting experiment on the provision of choice. She carried out a social experiment where consumers shopping at a grocery store encountered a tasting booth for jam that offered either 6 or 24 different flavors. The results showed that more consumers stopped at the tasting booth displaying 24 flavors, but when it came to purchasing behavior, consumers who were exposed to 6 flavors were more likely to purchase the product. This implies that extensive options can attract people's interest, yet when they are too extensive they tend to reduce people's motivation to make a choice. Many might perhaps feel that this notion is reflected in current developments in cashless payments in Japan. If central banks issue CBDCs and many consumers begin to use them, there is certainly the possibility that this would lead to a resolution of the crowding of cashless payment instruments. In fact, looking back at the history of currency globally, the issuance of banknotes has become limited to central banks as the issue of banknotes by multiple private banks in the past led to their uncontrollable increase, causing economic turmoil. That said, it is not appropriate to identify the current retail payments market with the past where the uncontrollable increase in the issue of banknotes by multiple institutions caused turmoil. The retail payments market is now in a phase where FinTech firms and financial institutions are competing with each other in payments innovation. The Bank of Japan judges that it is important for now to promote innovation in the private sector, as it has strong information technology capabilities. If the current crowding of cashless payment instruments is maintained forever, it would reduce consumers' economic welfare, but such a situation will likely be resolved eventually in the process of competition. Maintaining the Competitive Environment in the Retail Payments Market On the other hand, leaving the competition up to the market may not lead to desirable outcomes in the long term; it could possibly result in "market failure." The payment and settlement systems have "network externalities" where the wider a network is, the more benefit the participants in the network can enjoy. For this reason, if the number of users and merchants in the network exceeds a certain scale -- "a critical mass" -- the scale of the payment platform would expand greatly, leading to an oligopoly or monopoly in the retail payments market. If specific businesses gain strong control over the retail payments market, it could distort the pricing mechanism, decrease incentives for innovation, or increase systemic risk when problems arise. At present, the Japanese retail payments market is not facing any oligopoly or monopoly. However, a decline in competition in the retail payments market is now an issue in some countries like Sweden, where cash circulation is rapidly declining and society is becoming increasingly cashless. Some argue that the issuance of CBDC would contribute to maintaining the competitive environment in the retail payments market.2 It is believed that if a central bank builds cashless payment platforms, this would maintain the pressure on private sector firms to compete with each other. However, my take is that issuing CBDC is not the best option to promote competition in the retail payments market. The first possible prescription should be a government policy on competition, such as splitting up monopoly firms and strengthening regulations to resolve distortions in competition. Therefore, I believe it is not really appropriate to issue CBDC for the purpose of promoting competition in the retail payments market. Fundamental Functions of Currency and a Two-Tiered System To explore the rationale for issuing CBDC, we can simply get back to the fundamental roles of currency. Payment instruments that are safe, reliable, inexpensive, and available to all are essential to support economic activities. I think most people would agree that the central bank should continue to be responsible for supplying these instruments in the digital age as well. The rationale for issuing CBDC may basically rest on this. CBDC functions not only as a means of payment but also as a store of value. In normal times, people may not be aware of the difference between central bank money and private Walter Engert, Ben S. C. Fung, and Scott Hendry, "Is a Cashless Society Problematic?," Bank of Canada Staff Discussion Paper 2018-12, October 2018. money (i.e., money issued by the private sector); however, this is not the case in times of financial crisis or natural disaster. When people are anxious, the precautionary demand for central bank money free of credit risk tends to increase. When the Great East Japan Earthquake hit Japan, there was a significant increase in cash withdrawal in disaster areas.3 Also, when the Lehman Brothers bankruptcy led to a financial crisis in Iceland, demand for cash soared so high that the Central Bank of Iceland's inventory of banknotes was nearly exhausted.4 These facts show that it is reasonable to say that a framework should be in place to supply highly credible central bank money that is suitable for the digital age. Nevertheless, issuing CBDC in normal times with the purpose of preparing for crisis could pose a new challenge. For example, if CBDC starts to substitute for bank deposits, it could squeeze banks' credit intermediation and affect the real economy. There is also the view that CBDC, which functions as a safe haven in times of stress, would rather amplify the stress. Since all it takes is a few clicks on a computer or smartphone, a shift from bank deposits to CBDC would occur in a much more drastic way in the digital age than with traditional bank runs, and thus could exacerbate a financial crisis. This is called a "digital bank run." As we look deeper into these issues, we end up facing the issue of how we should treat the "two-tiered system," established in most modern states. Under the two-tiered system, a central bank exclusively supplies the public with central bank money consisting of cash and central bank deposits, and private banks provide deposits through credit creation based on the central bank money. The two-tiered system has various advantages regarding information processing and resource allocation. While the credibility of currency is ensured by central bank money, financial resources are efficiently allocated through private-led initiatives. Private sector innovations are greatly utilized in the area of payment services. For example, new cashless payment instruments offered by FinTech firms provide better user interface using smartphones and make payment using deposits very handy. Bank of Japan Payment and Settlement Systems Department, "Higashi Nihon Daishinsai chokugo no kin'yū kessai-men no dōkō: dēta ni motozuku jijitsu seiri," Bank of Japan Research Papers, March 2013. 4 Central Bank of Iceland, "Rafkróna?," Central Bank Digital Currency Interim Report, September 2018. No matter how safe and reliable CBDC is as a payment instrument, the benefits derived from the two-tiered system would be lost if private money were to be replaced by CBDC on a considerable scale. When considering the design of payment and settlement systems, it is necessary to examine ways to improve the overall functions and credibility of the systems. In doing so, central bank money and private money should not be considered independently. We need to take into account the interrelations between the two. Next, I will discuss how the functions of private digital currencies can be improved to achieve a level close to the expected functions of CBDC in terms of creditworthiness, general acceptability, and settlement finality (Figure 7). 3. Improving the Functions of Private Digital Currency Creditworthiness of Private Digital Currency As I have mentioned earlier, in the digital age, it is important to prepare ourselves for crises with safe assets, and CBDC is an important possibility. However, it is also important to design a framework that improves the creditworthiness of private money, regardless of the issuance of CBDC. If the credit risk of private money could be minimized and the credit gap between private money and central bank money could be narrowed, the issue of a shift from bank deposits to CBDC could, in theory, be alleviated. In Japan, among the various types of private money, a framework of protection provided by deposit insurance for bank deposits was put firmly in place after the crisis of the late 1990s. As for electronic money issued by transport and distribution firms and FinTech firms, consumer protection is provided by securing assets. For example, firms issuing electronic money which is convertible to cash are required by law to secure funds equivalent to or more than the amount received from users, by making a security deposit or by other means. As for developments overseas, in China, BigTech firms, including Alipay and WeChat Pay, that provide payment services are required to deposit funds equivalent to the amount received from their users in accounts at the People's Bank of China. This could be seen as an example of a scheme where BigTech firms issue private digital currencies based on the credibility of a central bank. In terms of functionality, it is very much the same as narrow banking, where the central bank requires full reserves, and is almost equivalent to CBDC in terms of creditworthiness. To ensure the stability of the retail payment system as a whole, it is essential to design a framework that secures the creditworthiness of private digital currencies. The social impact would increase as the scale of the cashless payment platforms operated by the private sector grows. With regard to payment instruments and services, the authorities would therefore need to put an adequate risk-based regulatory framework in place. As for firms operating payment platforms, they would be required to take responsible action, including adoption of sophisticated risk management procedures and stringent responses to regulatory requirements. General Acceptability of Money Even if the creditworthiness of private digital currencies improves, it does not mean that they will be widely accepted as money. For instance, merchants participating in different payment platforms operated by FinTech firms do not necessarily overlap. This means that electronic money issued by a FinTech firm cannot be used in transactions with merchants participating in payment platforms operated by different FinTech firms. Moreover, users cannot conduct P2P money transfers across different payment platforms. Thus, electronic money issued by FinTech firms is at present considerably inferior to cash in terms of general acceptability. Overseas, there are cases where interoperability among payment service providers is ensured. For example, in Hong Kong, major banks and nonbank payment service providers (store value facilities) such as Alipay and WeChat Pay have joined the Faster Payment System -- a real-time funds transfer system which operates on a 24/7 basis -- launched by the Hong Kong Monetary Authority in 2018. This has enabled users of these service providers to conduct P2P money transfers. Users can even transfer funds to bank accounts using electronic money issued by these nonbank payment service providers. To the extent that interoperability is ensured, the general acceptability of electronic money issued by the private sector will likely increase. With regard to interoperability among private digital currencies, whether a central bank should allow new nonbank payment service providers, such as FinTech firms, to open current accounts at the central bank may be an issue for discussion. If the interoperability of private money is enhanced through safe and efficient settlement using central bank current accounts, private digital currencies could resemble CBDC in terms of general acceptability. However, central banks need to examine the notion of allowing nonbanks to access current accounts comprehensively from various aspects, including the potential impact on financial systems in addition to interoperability. Needless to say, nonbanks seeking access to payment and settlement systems via central bank current accounts would be required to meet strict standards in many areas, such as financial soundness, information security, and risk management. Overseas, nonbank payment service providers are now allowed to open current accounts at central banks in countries such as the United Kingdom and Australia. This is also currently under consideration in Switzerland and Singapore. Settlement Finality Now, I would like to touch upon the issue of "settlement finality." Finality means that settlement of an obligation is irrevocable. Central bank money is not only credit risk free, but also provides immediate finality. Banknotes can be used to settle obligations 24 hours a day, 365 days a year with finality. In Japan, the launch of the Zengin More Time System in October 2018 has enabled users to send funds on a real-time basis 24 hours a day, 365 days a year for transfers of less than 100 million yen per transaction (hereinafter referred to as "retail transfers"). It should be noted, however, that transactions between financial institutions, accompanying these retail transfers between users, are settled on a deferred net settlement (DNS) basis. Under a DNS system, payment instructions received from financial institutions are pooled until a designated time, and then the gross values of incoming and outgoing funds are netted out. Only the net amount is settled. While the efficient use of liquidity provided by DNS is an advantage, it accumulates unsettled positions up to the designated time, which means that settlement is not final until this net position is settled. In this way, DNS harbors a systemic risk; if even one of the participating financial institutions fails to meet its obligations, it could potentially start a chain reaction affecting all other institutions. If the number of retail transfers via deposit accounts at financial institutions increases with the progress toward a cashless society, it could bring an increase in intraday unsettled positions, thereby accumulating risks in payment and settlement systems as a whole. To address this concern, one option is to reduce dependence on settlement via deposit accounts at financial institutions by issuing a CBDC which provides immediate settlement finality. However, there are also other options; settlement methods of retail transfers between financial institutions could be changed from DNS to real-time gross settlements (RTGS). RTGS offers a simple way of settling funds where the central bank immediately executes payment instructions received from financial institutions. Under an RTGS system, as each payment is settled with finality in real time one after another, systemic risk can, to a large extent, be contained. To settle RTGS transactions 24 hours a day, 365 days a year, the central bank's system also needs to operate throughout the day. Meanwhile, new RTGS platforms, which enable retail transfers 24 hours a day, 365 days a year, have already been launched in places such as Australia, Hong Kong, and Europe. In these platforms, settlement finality is ensured, as with CBDC. I think that it is important for each jurisdiction to consider the most desirable way to settle retail transfers through cost-benefit analysis, while taking into account developments in payments and settlements in each country. IV. Concluding Remarks Today, I have had the pleasure of sharing with you my understanding on retail payments in the digital age, focusing on the relationship between central bank money and private money. Now, I would like to give you my own answer to the question I posed at the beginning: "Why are many central banks, including the Bank of Japan, committed to researching and studying into CBDCs even though they have no plan to issue them in the near future?" I have two reasons. First, since technological innovation evolves rapidly, the retail payments market structure could suddenly change dramatically, pushing us toward a cashless society. In some cases, the need for CBDC issuance may suddenly increase. To be able to adapt to such a situation, central banks need to deepen their understanding on the latest developments in information technologies and their applicability to CBDC. Second, as I have discussed in the latter half of my speech, through research into CBDC -- or through the CBDC lens -- central banks examine more fundamental questions such as: "What are the required functions of money?"; "What ways do we have of improving the complementary relationship between central bank money and private money?"; or "What ways do we have of enhancing the functionality of private digital currency?" This process can offer clues for ways in which payment and settlement systems as a whole can be improved. The Bank will continue to examine CBDC with these two aspects in mind. In this respect, allow me to introduce two of our recent initiatives. On the technological front, the Bank is continuing research into distributed ledger technology -- DLT. Project Stella, a joint research project with the European Central Bank is part of these initiatives.5 This project has resulted in three reports so far, exploring, for example, the applicability of DLT to payments using central bank deposits -- that is, wholesale CBDC. On the legal front, the Bank's Institute for Monetary and Economic Studies set up a study group on legal issues regarding CBDC in November 2018. It identifies potential legal issues that would arise if the Bank were to issue CBDC in response to rapid developments in technology and their possible interpretations. The report will be released in due course. The Bank will continue to work to improve the efficiency and safety of payment and settlement systems. It will examine, from various perspectives, the desirable nature of these systems, including the issue of CBDC. And this brings me to the end of my speech. Thank you very much for your attention. http://www.boj.or.jp/en/paym/fintech/index.htm/ Should the Bank of Japan Issue a Digital Currency? July 5, 2019 Speech at a Reuters Newsmaker Event in Tokyo Masayoshi Amamiya Deputy Governor of the Bank of Japan Bank of Japan Figure 1 Survey on CBDC Initiatives for CBDC Engagement in CBDC work1 Likelihood of issuing a CBDC going forward3 Type of CBDC work2 % % % Very unlikely Somewhat unlikely Possible No Somewhat likely Yes CY Very likely Research/study Experiments/ Development/ proof-of-concept pilot arrangement Short term Medium term Notes: 1. Share among the 63 respondent central banks. The sum of general purpose CBDCs and wholesale CBDCs. 2. Share among the respondent central banks that answered that they were engaged in CBDC work in 2018 survey (multiple answers were allowed). The sum of general purpose CBDCs and wholesale CBDCs. 3. Share among the 63 respondent central banks. Figures are for general purpose CBDCs. "Short term" denotes 1-3 years and "Medium term" denotes 4-6 years. Source: Christian Barontini and Henry Holden, "Proceeding with Caution -- A Survey on Central Bank Digital Currency," BIS Papers, No.101, January 2019. Figure 2 Share of Payment Instruments in Private Consumption Expenditure Cash (48.2%) Credit cards (31.4%) Direct debit (10.5%)* Prepaid electronic money (5.0%) Internet banking (1.4%)* Bank transfer (using bank cards) (0.9%)* Debit cards (0.8%) Share of cashless payments FinTech services (0.7%) (51.8%) Deduction from salaries (0.2%)* Crypto-assets (0.1%) Other non-cash payment instruments (0.8%) Share of transfers between bank accounts (sum of instruments with asterisks[*]): 13% Note: In the figure "prepaid electronic money" refers to services such as Suica, PASMO, Rakuten Edy, nanaco, and WAON. "FinTech services" refers to payment services -- other than prepaid electronic money -- that is provided by FinTech firms; the services include iD, QUICPay, Alipay, WeChat Pay, Apple Pay, Google Pay, Rakuten Pay, LINE Pay, and Origami Pay. The survey was conducted online with a nationwide sample of 3,000 individuals who are between the ages of 20 and 69. Source: The Nippon Institute for Research Advancement (NIRA), Survey on Cashless Payments in Japan, September 2018 (available only in Japanese). Figure 3 Amount of Cash in Circulation Amount of banknotes in circulation Amount of coins in circulation Annual average, 100 million Change in the amount of banknotes/coins in circulation for 2018 Annual average, 100 million Year-on-year change, % 10,000 yen 5,000 yen 2,000 yen 1,000 yen 500 yen 100 yen 50 yen 10 yen 5 yen 1 yen Nominal GDP growth rate for 1 yen 5 yen 10 yen 50 yen 100 yen 500 yen CY85 1,000 yen CY 85 2,000 yen 5,000 yen -1 10,000 yen Source: Bank of Japan. Figure 4 International Comparison of the Number of Financial Institutions' Branches and Cash in Circulation International comparison of the number of financial institutions' branches per habitable area Correlation between the ratio of cash in circulation to GDP and the number of branches per habitable area Number of branches per 10,000 km2 100,000 Ratio of cash in circulation to GDP, % 10,000 Japan 1,000 Hong Kong Switzerland Russia Saudi Arabia Argentina Hong Kong Singapore Japan Belgium South Korea Italy Germany France Spain Switzerland India Netherlands Indonesia United States Turkey Sweden Mexico Brazil Russia South Africa Argentina Canada Saudi Arabia Australia United States Singapore India Mexico Turkey Australia Canada South Africa Indonesia South Korea Brazil Sweden number of branches per 10,000 km2 habitable area (logarithmic value) Note: The figure shows the latest possible international comparison as of the end of 2016 (the figure for Japan is as of the end of fiscal 2016). The habitable area is calculated by deducting the forest areas from the total area. Sources: BIS, Statistics on Payments and Financial Market Infrastructures; World Bank; IMF, etc. Issuance Forms of CBDC Figure 5 Account-based CBDC Token-based CBDC Central Bank User's account Opens an account, deposits cash Central Bank Merchant's account (3) Account transfer instruction Deposits cash (2) Shopping User Merchant (1) A user opens an account and deposits cash at a central bank. (2) The user shops at a merchant. (3) The user sends an account transfer instruction to the central bank. (4) The central bank transfers CBDC to the merchant's account. User Issues CBDC (2) Shopping Merchant (1) A central bank issues CBDC to a user in exchange for cash. CBDC is stored on the user's smartphone application or IC card. (2) When the user shops at a merchant, CBDC is transferred to the merchant's terminal, etc. Figure 6 Expected Roles for CBDC Effectiveness on monetary policy The level of interest rates applied to CBDC could work as the effective lower bound of interest rates for wide-ranging financial assets? Resolving the crowding of cashless payment instruments Will issuing CBDC promote the unification of all cashless payment instruments? The crowding of cashless payment instruments will likely be resolved in the process of competition. Maintaining the competitive environment in the retail payments market Will issuing CBDC maintain the pressure on private sector firms to compete with each other? The role of a government policy on competition. Fundamental functions of currency and a two-tiered system Central banks should continue to supply payment instruments that are safe, reliable, inexpensive, and available to all in the digital age as well. Under the two-tiered system, overall functions of payment and settlement systems should be examined, while taking into account the interrelations between central bank money and private money. Figure 7 Improving the Functions of Private Digital Currency Creditworthiness of private digital currency It is important to minimize the credit risk of private digital currencies and narrow the credit gap between private money and central bank money for the stability of financial system and payment and settlement systems. General acceptability of money Ensuring interoperability among payment service providers can increase the general acceptability of private digital currencies. Overseas, there are cases where nonbank payment service providers and banks participate in the same payment and settlement platforms. Settlement finality Settlement finality is ensured in RTGS platforms that enable retail transfers on a 24/7 basis as with CBDC. Overseas, such RTGS platforms have already been launched in some places.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2019 Michel Camdessus Central Banking Lecture, International Monetary Fund, Washington DC, 22 July 2019.
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July 22, 2019 Bank of Japan Overcoming Deflation: Japan's Experience and Challenges Ahead Speech at the 2019 Michel Camdessus Central Banking Lecture, International Monetary Fund Haruhiko Kuroda Governor of the Bank of Japan Introduction It is my great pleasure to have the opportunity today to give a speech in honor of Michel Camdessus. In my speech today, I would like to share some thoughts on Japan's deflation that started from the late 1990s, when Mr. Camdessus served as the Managing Director of the International Monetary Fund (IMF). The inflation rate in Japan started to decline after the burst of the asset bubble in the early 1990s. The economy fell into deflation in the late 1990s, in the sense of a sustained decline in prices, and this deflation persisted for about 15 years. Such chronic deflation used to be regarded as a phenomenon unique to Japan. However, most advanced economies have been experiencing low inflation and low interest rates since the global financial crisis. Many central banks now face a common challenge of how to raise inflation rates. I believe that Japan's experience of a long battle against deflation would provide a case study for other central banks in conducting monetary policy going forward. Keeping this in mind, I would like to discuss two topics today. The first is the reasons behind chronic deflation in Japan and the effects of quantitative and qualitative monetary easing (QQE) that the Bank of Japan introduced in 2013 as a measure to overcome deflation. As I will explain later, Japan's economy is finally no longer in deflation owing to the powerful monetary easing, and it is reconfirmed that monetary policy is effective even in overcoming chronic deflation. However, it is taking time to achieve the Bank's price stability target of 2 percent. After explaining the reasons behind this, I will move on to the second topic of the Bank's initiatives to overcome the current persistent low inflation. The Bank introduced the new policy framework, "QQE with Yield Curve Control," in 2016 and strengthened it in 2018. I will elaborate on the Bank's thinking behind the new initiatives and its experience. I. Chronic Deflation and QQE A. Decline in the Natural Rate of Interest and Chronic Deflation Now, let me start with Japan's experience of deflation. In Japan, after the burst of a large-scale asset bubble in the early 1990s, the economy decelerated significantly and the inflation rate declined gradually. The economy fell into deflation amid the successive collapse of major financial institutions in the late 1990s. Thereafter, except for some periods when commodity prices surged, the CPI inflation rate remained in negative territory for about 15 years (Chart 1). Why did Japan's economy fall into deflation and face difficulty in getting out of it for a long time? In my view, this is basically because the natural rate of interest declined rapidly, due to the stagnant potential growth rate, the bubble burst, and the subsequent financial crisis (Chart 2).1 The Bank had been searching for measures to strengthen monetary easing from an early stage. It adopted the zero interest rate policy in 1999 and introduced quantitative easing (QE) in 2001 ahead of other central banks. However, it could not create sufficiently accommodative financial conditions in a situation where the nominal policy interest rate had already reached the zero lower bound, and QE at that time simply exchanged nearly zero interest rate short-term assets for zero interest rate deposits at the Bank of Japan. In addition, amid a situation of stagnant economic activity and prices, it was perceived by the public and markets that the Bank did not commit strongly enough to achieving price stability. This also gradually pushed down inflation expectations and made it more difficult to overcome deflation. B. Developments in Economic Activity and Prices since the Introduction of QQE In order to break through this situation, the Bank introduced QQE in April 2013. This framework of powerful monetary easing consists of two pillars: (1) a strong and clear commitment to achieving the price stability target of 2 percent at the earliest possible time and (2) large-scale purchases of short- to long-term government bonds to reduce long-term interest rates. Nao Sudo, Yosuke Okazaki, and Yasutaka Takizuka, "Determinants of the Natural Rate of Interest in Japan: Approaches Based on a DSGE Model and OG Model," Bank of Japan Research Laboratory Series, no.18-E-1, 2018. QQE exerted significant effects, supported by the favorable economic conditions at the time. Nominal interest rates declined largely across the entire yield curve. In particular, long-term interest rates were influenced strongly, since they had room for a further decline even under the zero lower bound on short-term interest rates. With concern about the persistent deflation being dispelled, inflation expectations rose, and short- and long-term real interest rates fell to a level far below the natural rate of interest. As a consequence, the economy improved significantly and the inflation rate went up. For the first time in about 15 years, Japan's economy is no longer in deflation. Since the global financial crisis, the inflation rate in Japan alone has increased, while the rates in many advanced economies have declined. This indicates the significant effects of QQE (Chart 3). That said, the inflation rate is still below 1 percent and the low inflation environment remains. As I just mentioned, in Japan, powerful monetary easing has boosted demand through a decline in real interest rates. This transmission mechanism has worked firmly as initially intended. However, the problem is that, even though demand shortage was met, it is still taking time to overcome low inflation. C. Reasons Why It Takes Time for Inflation to Rise In our understanding, the combination of a vulnerability of inflation expectations to adverse shocks and structural factors explains why a rise in inflation is taking time. Inflation expectations started to rise following the introduction of QQE in 2013, but leveled off around the next summer and started to decline thereafter. Such a decline was largely due to a drop in the inflation rate that mainly reflected a significant fall in crude oil prices. In 2014, Japan's economy was halfway through the re-anchoring process from a deflationary equilibrium to a new equilibrium. Unfortunately, the economy faced large adverse price shocks at such a critical point, and inflation expectations stopped rising as they are vulnerable to such shocks before they are well anchored.2 As for the effects of price shocks on inflation expectations, see Yoshihiko Hogen and Ryoichi Okuma, "The Anchoring of Inflation Expectations in Japan: A Learning-Approach Perspective," Bank of Japan Working Paper Series, no.18-E-8, 2018. However, inflation remained sluggish even after 2016, when crude oil prices started to increase. So, it is not possible to attribute the reason only to past price shocks. Let me introduce some hypotheses that focus on structural factors to explain the current sluggish inflation. The first is that the hysteresis effects of inflation expectations are stronger than expected. The introduction of QQE dispelled an extremely pessimistic view that deflation would continue. However, the experience of prolonged low growth and low inflation has become deeply embedded in people's mindset and behavior, and the assumption that prices will not increase easily has been entrenched. Recently, many analyses show that households' inflation expectations are significantly affected by their experience for a long time. For example, compared to the age group who experienced relatively high inflation, inflation expectations are lower for younger generations in Japan. They only have the experience of low inflation and deflation.3 The second hypothesis is that the past experience of deflation and recent technological innovation have constrained the unit labor cost and this mechanism has worked strongly. Even though the unemployment rate has declined to about 2.5 percent and the tightening of labor market conditions has been evident, wage growth for regular employees has remained moderate. Because of the long experience of a severe employment situation under deflation, both labor and management may have come to prioritize the stability of long-term employment over immediate wage increases.4 In fact, wages of part-time workers, whose employment can be adjusted more flexibly, have been increasing by more than 2 percent, while those of regular workers increasing by less than 1 percent. In addition, the unit labor With regard to the characteristics of households' inflation expectations by generation in Japan, see Jess Diamond, Kota Watanabe, and Tsutomu Watanabe, "The Formation of Consumer Inflation Expectations: New Evidence from Japan's Deflation Experience," CARF Working Paper, CARF-F-388, 2017. Regarding the effects of the past employment situation on the present wage-setting stance, see Yuto Iwasaki, Ichiro Muto, and Mototsugu Shintani, "Missing Wage Inflation?: Estimating the Natural Rate of Unemployment in a Nonlinear DSGE Model," IMES Discussion Paper Series, no.2018-E-8, 2018. cost is constrained by offsetting a rise in labor cost with an improvement in productivity. Since the IT investment using the recent digital technology is highly substitutable to labor, it may constrain a rise in real wages (Chart 4). In addition to the two factors that I explained, there are many others, including the progress in globalization. Various factors are interacting with each other and working on prices. For example, when households strongly believe that prices will not increase easily, firms may become cautious about raising their prices for fear of losing their customers, and thereby try to constrain the unit labor cost or markup. Reflecting these various factors, the Phillips curve in Japan has flattened, and it has taken time for the curve to shift upward due to the delay in a rise in inflation expectations. I think Japan's experience may be a clue to explaining the "missing inflation" in advanced economies. The United States and Europe suffered severe economic downturns after the global financial crisis as well as the prolonged low growth and low inflation environment since then. As with Japan's experience of deflation, such severe situations may have affected the mindset and behavior of households and firms in those countries. The progress in digitalization and globalization is also common among advanced economies. II. Lessons Learned from Japan's Experience and Challenges Ahead So far, I have talked about the first topic of Japan's experience of deflation and the Bank's powerful monetary easing to overcome it. I also explained the reasons behind the persistent low inflation. Now, I would like to move on to the second topic of the Bank's challenges under the low inflation environment. Regarding the monetary policy conduct, I think that the Bank learned two lessons from the past experience. First, even in the face of a substantial decline in the natural rate of interest, it is possible to realize accommodative financial conditions and stimulate economic activity and prices by strengthening monetary easing. We have not yet fully understood the effects and side effects of unconventional monetary policy, but there is no need to be too pessimistic about them. Second, we need to bear in mind that it may take time to overcome entrenched low inflation, even with the powerful monetary easing. Of course, this does not mean that the inflation rate will never rise again. In Japan, firms' moves to raise wages and prices have been spreading gradually, while the economy has continued on an improving trend. The Bank considers it important to persistently support such moves through monetary policy. We need to maintain upward pressure on the inflation rate for as long as possible and encourage people to change their mindset and behavior. Based on this understanding, the Bank has pursued powerful monetary easing since the introduction of QQE that is called a "new phase of monetary easing." However, it is not easy to continue with such powerful measures for a long time. Next, I would like to talk about three points regarding the challenges in maintaining accommodative financial conditions and the Bank's initiatives to overcome them. A. Communication and Expectation Management The first challenge is how to communicate with the public in order to manage people's expectations effectively. Expectation management is one of the most fundamental elements of monetary policy conduct, and in particular, forward guidance regarding the future policy stance plays an important role under the low interest rate environment. In a standard economic model, even when short-term interest rates reach the effective lower bound, if a central bank announces that it will maintain accommodative financial conditions for a long time, the behavior of each economic entity could change, thereby producing significant monetary easing effects. In reality, however, people's behavior does not seem to change as much as the theory suggests, especially when the forward guidance horizon becomes longer. One of the reasons behind this "forward guidance puzzle" is the difficulty in assuring people's understanding of the central bank's guidance for the distant future. The central bank's guidance cannot gain confidence unless people perceive it as realistic and time consistent. However, if the central bank focuses too much on such consistency and makes the guidance complicated, it becomes more difficult to convey its thinking to the public. As suggested by recent studies on the "rational inattention," households and firms do not always pay close attention to monetary policy or price developments. So, the central bank needs to clearly explain its thinking in plain language in order to manage their expectations. On this basis, the Bank of Japan has adopted two types of forward guidance. The first is an "inflation-overshooting commitment" introduced in September 2016. This is a commitment that the Bank will continue expanding the monetary base until the observed inflation rate exceeds 2 percent and stays above that level in a stable manner. By linking to the price stability target, the Bank clearly shows its determination to maintain accommodative financial conditions for longer than assumed in a standard economic model. The second is "forward guidance for policy rates" introduced in July 2018. This shows the Bank's intention to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices. Through this forward guidance, the Bank has made clear that it considers it appropriate to maintain the current low levels of interest rates for such a long time. It also has clarified the time frame to make its intention easy to understand. Since the introduction of forward guidance for policy rates, the survey results show that an increasing number of market participants consider that interest rates will remain low (Chart 5). This indicates the effectiveness of such guidance. B. Securing Effective Policy Measures The second challenge in maintaining accommodative financial conditions for a long time is to secure highly sustainable policy measures. In order to address this challenge, in September 2016, the Bank decided to place yield curve control at the core of the monetary policy framework. Under yield curve control, the Bank aims to control both short- and long-term interest rates, setting the target level of 10-year Japanese government bond (JGB) yields at around zero percent. The previous policy framework that set the amount of JGB purchases as the operating target was simple to operate in practice. However, there was a problem that the degree of downward pressure on the yields could change to a large extent, depending on economic and market conditions at the time. In contrast, under yield curve control, the Bank sets the specific target level of interest rates and conducts JGB purchases so as to achieve this target. In exerting monetary easing effects stably for a long time, the Bank judges that yield curve control is a better framework in terms of both controllability and sustainability. There are several points that warrant attention in order to elicit the utmost effects of yield curve control. The first is to secure confidence that a central bank can actually control long-term interest rates. Unlike the money market dominated by the central bank, the government bond market consists of various participants, and the price mechanism is more complex. Based on our experience, in order to control long-term interest rates, the central bank needs to gain a strong presence in the government bond market. It also is important to develop and secure effective operational measures to realize fine-tuned interest rate control. More specifically, the Bank already holds more than 40 percent of JGBs on a stock basis. Also, its share of JGB transaction volume on a flow basis has been at a high level (Chart 6). Long-term interest rates have been controlled by changing the amount of JGB purchases appropriately, based on the premise that the Bank has a strong presence in the JGB market in terms of both stock and flow.5 When yield curve control was introduced in September 2016, there were skeptical views about the Bank's ability to control interest rates. In fact, when U.S. and European long-term interest rates rose significantly from late 2016 to early next year, there was sudden upward pressure on JGB yields as well. In this phase, the Bank used a powerful tool called "fixed-rate purchase operations," in which it buys unlimited amounts of JGBs at a specific interest rate level. As this new tool was used in a timely manner, market confidence regarding the Bank's ability to control interest rates has strengthened. Since mid-2017, long-term interest rates have shown a greater tendency to move at around the target level. For the effects of JGB purchases on long-term interest rates in Japan, see Nao Sudo and Masaki Tanaka, "Do Market Segmentation and Preferred Habitat Theories Hold in Japan?: Quantifying Stock and Flow Effects of Bond Purchases," Bank of Japan Working Paper Series, no.18-E-16, 2018. The second point is to maintain the minimal market functioning while controlling the long-term interest rates appropriately. Of course, there is a trade-off between strengthening a central bank's ability to control interest rates and maintaining the market functioning. Increasing market confidence in the central bank's ability implicitly works as a put option. If this situation progresses further, the market functioning could be overly constrained. In fact, from around early 2018, as confidence in the effectiveness of yield curve control strengthened, daily fluctuations in JGB yields clearly became smaller and the JGB transaction volume also showed a decreasing trend (Chart 7). To deal with this difficult situation, in July 2018, the Bank clarified that long-term interest rates might move upward and downward to some extent mainly depending on developments in economic activity and prices, and made clear that it would conduct JGB purchases in a more flexible manner depending on market conditions. Meanwhile, the Bank has proceeded with adjustments to maintain and improve the market functioning, for example, by relaxing the terms and conditions for the Securities Lending Facility (SLF). Reflecting these efforts, price movements and the transaction volume of JGBs have recovered recently. As I mentioned earlier, yield curve control was introduced in 2016 to enhance the sustainability of the monetary easing policy. In addition, I believe that the Bank can maintain accommodative financial conditions for a long time by continuously making efforts to strike a balance between conducting yield curve control as well as maintaining and improving the market functioning. C. Examination of the Financial Functioning The third challenge in continuing with powerful monetary easing is to examine its impact on the financial functioning. To achieve price stability, it is essential to ensure financial stability and sustain the transmission mechanism of monetary policy. If long-term and super-long-term interest rates decline excessively, the rates of return on insurance and pension products also will decline. The Bank considers it necessary to pay attention to the possibility that this will give rise to a feeling of anxiety about the sustainability of financial functioning in a broad sense. The Bank also has examined whether the prolonged low interest rates will lead to an expansion of leverage due to excessively bullish expectations and whether they will result in the malfunctioning of financial intermediation through the impact on profits of financial institutions. Out of the two effects stemming from the prolonged low interest rates, the latter warrants more attention at this point. Excessively low interest rates could make financial institutions reluctant to lend, such as through capital constraints, and thereby diminish the monetary easing effects. In addition, if financial institutions take excessive risks under the severe profit environment in order to acquire immediate profits, the vulnerability of the financial system could increase in the longer term. These risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases. However, we will continue to pay attention to whether there are any changes in financial institutions' behavior or the functioning of financial intermediation amid continued accommodative financial conditions. Conclusion As time is running out, I would like to conclude my speech. In recent years, low inflation and low interest rates have been prolonged globally, and many central banks face a common challenge of how to raise inflation rates. Based on this recognition, I talked about Japan's experience and challenges from a somewhat long-term perspective, as Japan faced low inflation and low interest rates at an early stage and has continued to make various efforts to overcome this situation. Japan's economy has improved significantly while the Bank has continued with powerful monetary easing through "QQE with Yield Curve Control." The positive annual CPI inflation has taken hold, and the economy is no longer in deflation in the sense of a sustained decline in prices. That said, annual CPI inflation is in the range of 0.5-1.0 percent. The Bank will persistently continue with powerful monetary easing in order to maintain the momentum toward achieving 2 percent inflation. Recently, uncertainties regarding the global economy have been heightening, and some nervousness has been seen in global financial markets. The Bank needs to pay close attention to the effects of these developments on Japan's economic activity and prices. We will carefully examine various risk factors, in addition to developments in economic activity and prices as well as financial conditions, and weigh the benefits and costs of the policy effects. In this way, the Bank will continue to conduct its policy in an appropriate manner. Thank you very much for your attention. Overcoming Deflation: Japan's Experience and Challenges Ahead Speech at the 2019 Michel Camdessus Central Banking Lecture, International Monetary Fund July 22, 2019 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Chronic Deflation, and Quantitative and Qualitative Monetary Easing (QQE) II. Lessons Learned from Japan's Experience and Challenges Ahead Conclusion Chart 1 I. Chronic Deflation and QQE Consumer Prices y/y % chg. Introduction of QQE -1 CPI (all items less fresh food) -2 CPI (all items less fresh food and energy) -3 CY 85 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 2 I. Chronic Deflation and QQE Natural Rate of Interest % Potential growth rate R* in the DSGE Model R* estimated based on Laubach and Williams R* estimated based on Imakubo et al. R* estimated based on the HP Filter -1 -2 CY85 Notes: 1. Figures for the potential growth rate are based on staff estimations. Notes: 2. For details of the methodologies used in this chart, see Nao Sudo, Yosuke Okazaki, and Yasutaka Takizuka, "Determinants of the Natural Rate of Interest in Japan: Approaches Based on a DSGE Model and OG Model," Bank of Japan Research Laboratory Series, no.18-E-1, 2018. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bank of Japan. Chart 3 I. Chronic Deflation and QQE QQE and Price Developments Japan's Consumer Prices Price Developments in G7 Countries y/y % chg. 3.0 Average from 2000 through 2012 Introduction of QQE 2.5 CPI (all items less fresh food and energy) y/y % chg. Average from 2013 through 2018 2.0 1.5 1.0 Average from 2013/Q2 through 2019/Q2 + 0.5% -1 Average from 2000/Q1 through 2013/Q1 - 0.5% 0.5 -2 0.0 -3 CY00 -0.5 Japan U.S. Germany U.K. France Italy Canada Notes: 1. Figures for Japan are adjusted for changes in the consumption tax rate. Notes: 2. In the right chart, figures for Japan, U.K., and Canada are the CPI; those for U.S. are the PCE deflator; and those for the euro area countries are the HICP. Sources: Ministry of Internal Affairs and Communications; Haver. Chart 4 I. Chronic Deflation and QQE Mechanism of Constraint on ULC Wages of Full-Time and Part-Time Employees Elasticity of Substitution between Labor and Capital y/y % chg. 1.2 Scheduled cash earnings (full-time employees) 1.0 Hourly scheduled cash earnings (part-time employees) All capital 0.8 0.6 0.4 -1 0.2 -2 CY09 elasticity IT investment 0.0 All industries Manufacturing Nonmanufacturing Notes: 1. In the left chart, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures from 2013/Q1 are based on corrected figures adjusted for establishments in Tokyo with 500 or more employees. Figures from 2016/Q1 are based on continuing observations following the sample revisions of the "Monthly Labour Survey." Notes: 2. In the right chart, the impacts of changes in the ratio of capital cost to real wages on the capital-labor ratio are estimated by the data classified by type of industries. The estimation period is 1995-2017. Industry fixed effects are considered. The error bands indicate ±1 standard deviation. Sources: Ministry of Health, Labour and Welfare; Ministry of Finance; Cabinet Office; Bloomberg; Bank of Japan. Chart 5 II. Lessons Learned from Japan's Experience and Challenges Ahead Forward Guidance for Policy Rates Forecasts for the Target Level of the Long-Term Interest Rate at End-2019 BOJ's Forward Guidance July 2018 "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019." number of respondents July 2018 survey (before the introduction of forward guidance) October 2018 survey May 2019 survey April 2019 "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike." -0.1～ 0.0 0.0～ 0.1 0.1～ 0.2 0.2～ 0.3 0.3～ 0.5 0.5～ 0.75～ 0.75 1.0 % Source: JCER, "ESP Forecast." Chart 6 II. Lessons Learned from Japan's Experience and Challenges Ahead Structure of the JGB Market Amount of Holdings by Sector (Stock Basis) Transaction Volume by Sector (Flow Basis) tril. yen tril. yen BOJ BOJ Banks Insurance Domestic banks and investors Pensions Overseas investors Overseas CY 11 CY 11 Notes: 1. JGBs exclude T-Bills. Notes: 2. In the right chart, figures basically indicate the amount of JGBs sold by dealers, excluding inter-dealer transactions. Note that figures for "BOJ" indicate the total amount of JGBs purchased by the BOJ, including those from entities other than dealers. Sources: JSDA; Bank of Japan. Chart 7 II. Lessons Learned from Japan's Experience and Challenges Ahead Functioning of the JGB Market Developments in the JGB Transaction Volume JGB Yield Elasticity to U.S. Long-Term Interest Rates 0.20 elasticity to a rise in U.S. long-term interest rates by 1bp, bps Strengthening the Framework for Continuous Powerful Monetary Easing (July 2018) tril. yen Strengthening the Framework for Continuous Powerful Monetary Easing (July 2018) 0.15 Average from CY 2016 through 2017 0.10 0.05 0.00 Transaction volume in the JGB market 6-month backward moving average -0.05 Jan. Jul. Jan. Jul. Jan. Jul. CY13 Notes: 1. In the left chart, figures are slopes in a simple regression model (90-day backward rolling regression) in which the dependent variable is daily changes of 10-year JGB yields and the explanatory variable is daily changes of 10-year U.S. Treasury yields (one-period lag). Shaded areas indicate ±1 standard error bands. Note: 2. In the right chart, the transaction volume is the gross amount purchased by banks, investors, and bond dealers. JGBs exclude T-Bills. Sources: Bloomberg; JSDA.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kagoshima, 1 August 2019.
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August 1, 2019 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kagoshima Masayoshi Amamiya 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 Kagoshima 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 Kagoshima Branch. At the outset, I would like to offer my heartfelt sympathies to those who are suffering from the heavy rain since end-June. I understand that the disastrous damage is still evident in the region and sincerely hope for a swift and full recovery. At the Monetary Policy Meeting (MPM) held two days ago, the Bank updated its projections for Japan's economic activity and prices through fiscal 2021 and released them in its quarterly report, the July 2019 Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to explain the Bank's view on developments in economic activity and prices as well as the recent conduct of monetary policy, while outlining the July Outlook Report. I. Financial and Economic Developments Since this May, when the Reiwa era started, protectionist moves including the U.S.-China trade friction have intensified, and uncertainties over the outlook for the global economy have heightened. In this situation, financial markets in each economy have continued to show large fluctuations. Let me first talk about the current situation for overseas economies. Although overseas economies have been growing moderately on the whole, slowdowns have continued to be observed (Chart 1). The pace of increase in the world trade volume has been decelerating, mainly due to the U.S.-China trade friction and a slowdown in IT-related goods, and the diffusion indexes (DIs) for the business sentiment of manufacturing firms on a global basis fell below 50 in May, which is the borderline between improvement and deterioration of business conditions perceived by firms. Looking at developments in major regions, the U.S. economy has continued to expand moderately, supported primarily by an increase in private consumption. On the other hand, China's GDP growth rate for the April-June quarter of 2019 registered the record low figure of 6.2 percent since 1992, from when the data are available, mainly against the background of weakness in the manufacturing sector. The growth pace of the European economy, in particular Germany, also has been decelerating. Meanwhile, in global financial markets, stock prices in many economies declined through early June due to uncertainties over the global economy. Under these circumstances, major central banks have been shifting their policy stance from monetary tightening through end-2018, such as raising policy rates, to monetary easing. Last week, the European Central Bank (ECB) revised its forward guidance, which is its thinking about the future course of its policy rates, to a more accommodative one. The ECB also announced that it would start to consider additional easing measures. In addition, the Federal Reserve reduced its policy rate by 0.25 percent yesterday for the first time in about 10 and a half years. However, as I mentioned, the U.S. economy has continued to expand moderately. Federal Reserve Chair Powell explained that the policy rate cut this time was intended to insure against downside risks from weak global growth and trade policy uncertainty. Although Japan's economy, mainly the export sector, has been affected by the slowdown in the global economy, domestic demand such as business fixed investment has remained firm. Thus, the Bank judges that the economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating. This also can be confirmed by an indicator called the output gap, which represents the balance between demand and supply in the economy as a whole (Chart 2). A positive output gap shows excess demand, whereas a negative output gap indicates excess supply. The gap became positive around 2017 and thereafter widened within positive territory on the back of the economic expansion. It has remained substantially positive recently. Let me elaborate more on this by demand component (Chart 3). Exports have shown some weakness, reflecting a decline mainly in those of capital goods and IT-related goods for China, as well as the NIEs and the ASEAN economies, due to the slowdown in overseas economies. Looking at the business conditions DI in the June 2019 Tankan (Short-Term Economic Survey of Enterprises in Japan), the manufacturing sector -- which is susceptible to developments in overseas economies -- has declined somewhat significantly for two consecutive quarters. On the other hand, domestic demand has remained firm, as evidenced by the business conditions DI for the nonmanufacturing sector staying at a favorable level. With corporate profits staying at high levels on the whole, business fixed investment has continued on an increasing trend (Chart 4). For each Tankan survey, the business fixed investment plans tend to show certain revision patterns. Looking at the June Tankan, the plans for fiscal 2019 indicate that business fixed investment is expected to continue increasing firmly, exceeding the past averages in the June surveys. Business fixed investment seems to have been supported by investment in a wide range of areas, such as that (1) intended for domestic capacity expansion, (2) aiming at saving labor in order to deal with labor shortage, and in research and development for growth areas. Investment has been robust in the nonmanufacturing sector as well; for example, there has been a rise in construction of distribution facilities, reflecting an expansion in e-commerce, and of accommodation facilities targeted for inbound demand. Private consumption has increased moderately, with the employment and income situation continuing to improve steadily. It is said that an increase in demand prior to the scheduled consumption tax hike has been seen in part, including sales of automobiles and household electrical appliances, but it seems only marginal compared with that of the previous hike. Looking at consumption-related indicators, inbound demand from foreign visitors has increased significantly for the past six years, by about four times. Foreign visitors to Kagoshima Prefecture also have surged since some additional international flights started operations at Kagoshima Airport. As there are a plenty of attractive areas in Japan, including this prefecture, there likely has been a steady rise in foreign visitors to a wider range of areas. With regard to the outlook, as described in the Bank's July 2019 Outlook Report, Japan's economy is likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021 -- despite being affected by the slowdown in overseas economies for the time being (Chart 5). Specifically, the real GDP growth rates are projected to be 0.7 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.1 percent for fiscal 2021. The Bank estimates that the economic growth rate that can be achieved in the long term, or the so-called potential growth rate, is nearly 1 percent. Thus, Japan's economy is expected to continue growing at a pace consistent with its potential. There are two important points in making an assessment of this outlook. The first is how overseas economies will pick up. The second point is the sustainability of domestic demand in the meantime. In what follows, I would like to explain these points, starting with the sustainability of domestic demand. With regard to private consumption, it is likely to continue on a moderate increasing trend as the employment and income situation continues to improve. Although the effects of the scheduled consumption tax hike warrant attention, they are projected to be smaller this time compared to those of the previous hike in 2014, partly due to a smaller burden for households from the tax hike and various measures introduced by the government to smooth out demand prior to and after the hike. In addition, public investment is likely to increase, mainly led by that in infrastructure due to policy measures for national resilience, and this will contribute to underpinning economic activity. Moreover, business fixed investment is the key to sustainability of domestic demand. As I explained, it is expected to continue increasing firmly in fiscal 2019. This is mainly supported by high levels of corporate profits, accommodative financial conditions, and steady demand for medium- to long-term strategic investment and for investment by the nonmanufacturing sector, both of which are relatively unsusceptible to changes in overseas demand and the business cycle. Going forward, business fixed investment is expected to increase moderately. Thus, the Bank recognizes that Japan's economy has become more resilient. However, there is a possibility that business and household sentiment will be affected depending on future developments in overseas economies and the markets. It is necessary to pay attention to the possibility that firms' investment stance will become cautious mainly in the manufacturing sector, if uncertainties concerning overseas economies in particular heighten further going forward. This leads to the next point of developments in overseas economies. Overseas economies are expected to grow moderately on the whole; although slowdowns are likely to continue for the time being, these economies are projected to pick up thereafter on the back of the effects of stimulus measures in China and the progress in global adjustments in IT-related goods, underpinned by accommodative financial conditions. The baseline scenario that overseas economies will pick up is basically unchanged. A similar outlook is presented in the World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF) in July (Chart 6). According to its outlook, global growth is projected to decelerate to 3.2 percent in 2019 but pick up to 3.5 percent -- about the same level as the past average -- in 2020. By region, it is projected that the U.S. economy will continue to expand moderately and that the Chinese economy will broadly follow a stable growth path with authorities conducting fiscal and monetary policies in a timely manner, despite being affected to some extent by the trade friction with the United States and deleveraging policy measures. In addition, the European economy is projected to gradually move out of its deceleration phase, reflecting progress in adjustments in the manufacturing sector, where relatively weak developments have been observed. That said, the downside risks concerning overseas economies have remained significant, and uncertainties regarding the effects of protectionist moves in particular have been heightening. Although the United States and China are still in negotiations to solve the trade issues, future developments in U.S. trade policy against China, as well as other economies, continue to warrant attention. Besides this trade friction, uncertainties concerning overseas economies include (1) the timing of when the effects of stimulus measures in China will materialize, (2) how far the adjustments in IT-related goods will progress, and (3) the consequences of negotiations on the United Kingdom's exit from the European Union (EU). It is necessary to pay attention to the risk that, if uncertainties concerning overseas economies heighten further going forward, domestic and foreign economies will be affected widely, not only through downward pressure on the trade activity of related economies but also deterioration in business sentiment and instability in financial markets. Thus, the Bank will carefully monitor whether overseas economies will pick up during the time when domestic demand, as I referred to earlier, is maintained firmly. II. Price Developments Next, I will explain price developments in Japan (Chart 7). For many years starting from the late 1990s, Japan's economy was in deflation in terms of a sustained decline in the consumer price index (CPI). In order to make a breakthrough in this situation, the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013, embarking on unprecedentedly powerful monetary easing. Since then, Japan's economy has improved significantly and the positive annual CPI inflation has taken hold. Thus, the economy is no longer in deflation, in the sense of a sustained decline in prices. Turning to recent price developments, the year-on-year rate of change in the CPI is at around 0.5 percent and has continued to show relatively weak developments compared to the economic expansion and tight labor market conditions. However, with the economy continuing on an expanding trend, the basic mechanism for moderate increases in wages and prices driven by a positive output gap has continued to operate. At this year's annual spring labor-management wage negotiations, base pay increases were achieved for a sixth consecutive year. The rate of increase as a whole was at about the same level as last year; in particular, that for small and medium-sized firms, which are susceptible to labor shortage, turned out to be relatively high. In addition to wages, other costs, such as distribution costs, have continued to increase. In this situation, firms have passed on cost increases to sales prices and such moves gradually have been spreading of late. Thus, prices seem to have become more stable recently. Let me introduce two examples (Chart 8). The first is price rises such as in food products, daily necessities, and services. Looking at prices of food products and daily necessities sold at supermarkets, the rates of increase have been accelerating clearly since April. In addition, the positive annual inflation in prices of dining-out and housework-related services among general services has taken hold. The second example is that firms' stance has shifted toward further raising prices, regardless of the firm size. Looking at the output prices DI of industries related to consumption, which has close relations with the CPI, since around 2017, the proportion of enterprises answering that the output prices have risen has exceeded the proportion of those answering that such prices have fallen, and the gap has expanded gradually. Of course, a rise in overall prices is not favorable for households if focusing only on the rise. What is important is that it should accompany improvement in the employment and income situation so that households can accept price rises (Chart 9). On this point, employee income, which is calculated as wages per employee multiplied by the number of employees, has continued to increase. This is because nominal wages have increased for the past few years and the positive rate of change in the number of employees has taken hold. Thus, the likely reason why prices have become more stable recently is that households' tolerance of price rises has risen, albeit moderately, with the employment and income situation improving. Now, I would like to move on to the outlook for prices (Chart 5). In the July 2019 Outlook Report, the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI excluding fresh food are 1.0 percent for fiscal 2019, 1.3 percent for fiscal 2020, and 1.6 percent for fiscal 2021. Annual CPI inflation is likely to increase gradually, but it is expected to still take time to achieve the price stability target of 2 percent. While there are various reasons for this, it seems to be affected largely by the fact that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched, due mainly to the experience of prolonged low growth and deflation from the late 1990s. As I mentioned earlier, firms' cautious wage- and price-setting stance, as well as households' cautiousness toward price rises, have shifted gradually but have not yet clearly changed. Firms have continued to make efforts to absorb upward pressure of costs on prices by increasing labor-saving investment and streamlining their business process. In addition, the progress in the labor force participation by women and seniors, which is desirable in terms of strengthening the growth potential of the economy as a whole, is another reason why it is taking time for prices to rise. Although it is taking time, the inflation rate is expected to increase gradually going forward. For the past few years, the situation has taken hold in which the year-on-year rate of change in the CPI has been positive, with the economy continuing on an expanding trend and the output gap having been substantially positive. The output gap is basically expected to remain substantially positive. Under these circumstances, firms' moves to raise prices are likely to be more widespread as households' tolerance of price rises increases, reflecting a rise in wage growth rates, and firms' stance shifts toward further raising prices. As people gain the collective experience of increases in wages and prices, the mindset and behavior based on the assumption that wages and prices will not increase easily are expected to weaken gradually. In this situation, inflation expectations -- that is, people's expectations for future price developments -- are projected to rise gradually. As these developments show, the Bank recognizes that the momentum toward achieving the price stability target has been maintained, whereby a positive output gap results in an increase in actual prices, leading to a rise in inflation expectations. However, attention should be paid to the possibility that the inflation momentum would be lost through, for example, shrinkage of the output gap or fluctuations in financial markets if risks to economic activity were to materialize, particularly regarding overseas economies, as I explained earlier. III. The Bank's Conduct of Monetary Policy Next, I would like to explain the Bank's conduct of monetary policy. The Bank has been conducting "QQE with Yield Curve Control" (Chart 10). Specifically, it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year Japanese government bond (JGB) yields at around zero percent, and has conducted large-scale JGB purchases in the market. Meanwhile, 10-year yields in Japan temporarily dropped to minus 0.195 percent amid the global decline in interest rates, and currently are at around minus 0.15 percent. In addition, the Bank has purchased assets such as exchange-traded funds (ETFs), with a view to lowering risk premia of asset prices. Under such powerful monetary easing measures, Japan's financial conditions have remained highly accommodative. Firms' funding costs have been hovering at extremely low levels (Chart 11). Lending rates have been at around historical low levels of around 0.5 percent, and issuance rates for corporate bonds have been at extremely low levels of close to 0 percent. In addition, financial institutions' lending attitudes have been active. Under these circumstances, the year-on-year rate of increase in bank lending has continued to register high growth in the range of 2-3 percent for more than six years, even in a situation where there have been excess savings in the household and corporate sectors on the whole. Therefore, highly accommodative financial conditions under the powerful monetary easing have stimulated firms' and households' spending activities, and thereby have significantly contributed to the positive output gap. In order to achieve the price stability target, the Bank considers it important to maintain the momentum toward achieving the price stability target by persistently continuing with the powerful monetary easing and thereby maintaining a positive output gap for as long as possible. So far, I have talked about the Bank's basic stance of monetary policy conduct. As I mentioned at the beginning, major central banks have been shifting their policy stance from monetary tightening to monetary easing amid high uncertainties over the global economy. In this situation, many have posed questions about the future policy conduct of the Bank of Japan. Therefore, I would like to talk about the basic thinking behind the relationship between the policy conduct of central banks abroad and that of the Bank of Japan. There are three points. First, the basic principle of the policy conduct for any central bank is to pursue appropriate conduct in response to domestic economic and price developments, and their policies should not be directly influenced by the policy stance of other central banks. Second, however, if factors that lie behind the policy conduct of other central banks affect economic and price developments of its own economy, it is of course necessary to take those into full account. The recent moves by the Federal Reserve and the ECB to change their policy stance are due to considerable uncertainties over the global economy. It is also important for the Bank of Japan to examine the risks concerning overseas economies and how these will affect Japan's economic activity and prices. And third, policy measures of major central banks warrant close monitoring in terms of their impact on domestic economic and price developments, as those measures will have certain effects on the global economy and global financial markets. On this point, the policy rate cut by the Federal Reserve this time was intended to prevent an actual slowdown in economic activity and inflation amid considerable uncertainties over the global economy. This policy rate cut will affect Japan's economy through various channels such as financial and foreign exchange markets as well as real economic activity. Basically, if the U.S. economy becomes more resilient, positive effects are likely to be exerted on the global economy and in turn Japan's economy. The Bank of Japan will continue to pursue policy conduct in an appropriate manner without preconception, taking account of developments in economic activity and prices as well as financial conditions in Japan, while carefully examining various risks. The Bank is no different from other major central banks, in that it is prepared to take, if necessary, policy responses in order to prevent the risks from materializing, while closely monitoring them. Based on this thinking, the Bank specified in the statement released after the MPM two days ago that "the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost." As has been made clear already, there are various possible measures for additional easing such as cutting the short-term policy interest rate, lowering the target level of 10-year JGB yields, expanding asset purchases, and accelerating the expansion of the monetary base. Combinations or applications of various measures also are possible. The Bank will take the most appropriate policy responses depending on the situation at the time, while weighing their benefits and costs and also taking full account of the viewpoint of preventing the materialization of a risk that the momentum toward achieving the price stability target will be lost. Conclusion Lastly, I would like to talk about the economy of Kagoshima Prefecture. In line with developments in Japan's economy as a whole, the prefecture's economic activity has been affected by the slowdown in overseas economies, mainly in terms of production, but it likely has continued to recover moderately led mainly by domestic demand. Private consumption has been firm, reflecting the improvement in the employment and income situation; in addition, tourism has remained solid, supported by an increase in both domestic and foreign visitors. Under these circumstances, business sentiment has remained favorable, and business fixed investment has grown steadily, supported mainly by strategic investment and labor-saving investment carried out from a medium- to long-term perspective. On the other hand, some have been worried about the outlook for the prefecture's economy from a somewhat medium- to long-term perspective. The likely reason behind this is concern about a shrinking of its market and shortage of human resources to support its economy in the face of issues such as the declining birthrate and aging population and the declining population overall. However, I believe that the people of this prefecture can overcome these issues. This is because Kagoshima Prefecture has a history of overcoming various hardships and successfully transforming itself. During the Edo era, the Satsuma clan faced a fiscal crisis, but it overcame this by expanding trade not only within the country but also with foreign countries through the Ryukyu Islands. At that time, in addition to developing trading routes using, for example, kitamaebune, or northern-bound ships, it focused on expanding trade in regional products such as kokuto brown sugar. These efforts became the driving force behind Japan's modernization by incorporating cutting-edge technologies such as those for steelmaking and spinning from overseas and developing them further, as seen in the subsequent Shuseikan industrial complex. In addition, by exhibiting Satsuma ware and earning high praise for it at the Paris Expo in 1867, the clan succeeded in establishing the "Satsuma" brand. Moreover, what supported this series of transformations was the development of human resources, such as through the traditional Goju education system that the clan established and the dispatch of exchange students to the United Kingdom. In studying this history, I feel that it has many parallels with the transformations that are required right now, which the prefecture already has been pursuing in fact. Examples include efforts to make inroads into markets outside the region, including abroad, while refining the brand value of agricultural and livestock products such as Kagoshima Black Beef, which has become the top beef brand in Japan. In addition, the prefecture has strengthened its efforts to attract tourists by taking advantage of its rich natural resources, such as Yakushima, which is registered as a World Natural Heritage site, its safe and high-quality food, and its abundant hot springs. The prefecture also has made efforts to use cutting-edge digital technologies, such as the implementation of smart farming and expansion of cashless payment services. Furthermore, with the involvement of Kagoshima University, collaboration between the industries, academics and research institutions, and the administration has been strengthened in order to enhance the effectiveness of these efforts. It is reassuring that these initiatives demonstrate the enterprising spirit etched into the DNA of the people of the prefecture. I sincerely hope that Kagoshima Prefecture, which in the past has turned various hardships into positive transformations, finds a new way forward and further develops its economy based on the initiatives that are currently under way. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kagoshima August 1, 2019 Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction I. Financial and Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Financial and Economic Developments Developments in the Global Economy World Trade Volume Global Manufacturing PMI y/y % chg. s.a., DI. Global economy Advanced economies Emerging and commodity-exporting economies -1 CY 12 CY12 Notes: 1. In the left chart, figures for the trade volume are those for real imports. Notes: 2. In the right chart, figures for the global economy are the "J.P. Morgan Global Manufacturing PMI." Figures for advanced economies as well as emerging and commodity-exporting economies are calculated as the weighted averages of the Manufacturing PMI using GDP shares of 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, such as China, South Korea, Taiwan, Russia, and Brazil. Sources: CPB Netherlands Bureau for Economic Policy Analysis; IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.), etc. Chart 2 I. Financial and Economic Developments Output Gap % Excess demand -2 -4 -6 -8 CY 08 Excess supply Note: The output gap is based on BOJ staff estimations. Source: Bank of Japan. Chart 3 I. Financial and Economic Developments Exports and Business Conditions Real Exports Business Conditions DI (Tankan) s.a., CY 2015=100 DI ("favorable" - "unfavorable"), % points Manufacturing Nonmanufacturing -5 -10 -15 CY12 -20 CY 12 Sources: Bank of Japan; Ministry of Finance. Chart 4 I. Financial and Economic Developments Business Fixed Investment Plans (Tankan) y/y % chg. FY 2018 FY 2019 average (FY 2004-2017) -2 Mar. June Sept. Dec. Forecast Actual Note: Figures are all industries including financial institutions. Including software and R&D investment and excluding land purchasing expenses (R&D investment is not included until the December 2016 survey). Source: Bank of Japan. Chart 5 I. Financial and Economic Developments Outlook for Economic Activity and Prices (July 2019 Outlook Report) the medians of the Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) (Reference) Excluding the effects of the consumption tax hike and policies concerning the provision of free education Fiscal 2019 ＋0.7 ＋1.0 ＋0.8 Forecasts made in April 2019 ＋0.8 ＋1.1 ＋0.9 Fiscal 2020 ＋0.9 ＋1.3 ＋1.2 Forecasts made in April 2019 ＋0.9 ＋1.4 ＋1.3 Fiscal 2021 ＋1.1 ＋1.6 Forecasts made in April 2019 ＋1.2 ＋1.6 Note: The direct effects of the consumption tax hike on the CPI for fiscal 2019 and fiscal 2020 are estimated to be 0.5 percentage point for each fiscal year. Those of policies concerning the provision of free education on the CPI for fiscal 2019 and fiscal 2020 are estimated to be minus 0.3 percentage point and minus 0.4 percentage point, respectively. Source: Bank of Japan. Chart 6 I. Financial and Economic Developments Overseas Economies IMF Projections for Major Economies (as of July 2019) y/y % chg. 3.8 3.6 3.2 3.5 Advanced economies 2.4 2.2 1.9 1.7 United States 2.2 2.9 2.6 1.9 Euro area 2.4 1.9 1.3 1.6 Japan 1.9 0.8 0.9 0.4 4.8 4.5 4.1 4.7 China 6.8 6.6 6.2 6.0 ASEAN-5 5.3 5.2 5.0 5.1 Latin America and the Caribbean 1.2 1.0 0.6 2.3 World Emerging market and developing economies Source: IMF. Projection Projection Chart 7 II. Price Developments Consumer Prices y/y % chg. -1 CPI (all items less fresh food) -2 CPI (all items less fresh food and energy) -3 CY85 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 8 II. Price Developments Price Situation Output Prices DI of Industries Related to Consumption (Tankan) Sales Prices at Supermarkets 2.5 y/y % chg. T-index (Nikkei CPINow) 2.0 CPI (based on items corresponding to the T-index) 1.5 1.0 DI ("rise" - "fall"), % points Forecast 0.5 0.0 -0.5 CY 15 -5 General Services -10 contribution to CPI (less fresh food and energy), % points 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 -0.5 CY 16 -15 -20 -25 Charges for package tours to overseas + hotel charges Telephone charges (mobile phone) Other services Eating out + services related to domestic duties General services (less house rent) -30 -35 CY 07 08 09 10 11 12 13 14 15 16 17 18 19 Notes: 1. In the top left chart, figures are adjusted for changes in the consumption tax rate. Notes: 2. In the right chart, figures are the weighted averages of the output prices DI of "retailing," "services for individuals," and "accommodations, eating and drinking services," using the number of enterprises that responded to the question as weights. Sources: NOWCAST, Inc.; Ministry of Internal Affairs and Communications; Bank of Japan. Chart 9 II. Price Developments Employee Income y/y % chg. -2 Total cash earnings -4 Number of employees Employee income -6 -8 Notes: 1. Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Notes: 2. Employee income = total cash earnings ("Monthly Labour Survey") × number of employees ("Labour Force Survey") Notes: 3. Figures of the "Monthly Labour Survey" from 2013/Q1 are based on corrected figures adjusted for establishments in Tokyo with 500 or more employees. Notes: 4. Figures from 2016/Q1 are based on continuing observations following the sample revisions of the "Monthly Labour Survey." Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 10 III. The Bank's Conduct of Monetary Policy Yield Curve Control % 1.0 Recent 0.8 July 27, 2016 (bottom) 0.6 Target level of the long-term Short-term policy 0.4 interest rate: interest rate: around zero percent minus 0.1 percent 0.2 0.0 -0.2 -0.4 -0.6 Source: Bloomberg. residual maturity, year Chart 11 III. The Bank's Conduct of Monetary Policy Financial Conditions Amount Outstanding of Bank Lending, CP, and Corporate Bonds Bank Lending Rates and Issuance Yields for CP and Corporate Bonds 2.0 % Bank lending rates (short-term) Bank lending rates (long-term) CP (3-month) Corporate bonds (AA) 1.8 1.6 Lending by domestic commercial banks CP and corporate bonds 1.4 1.2 1.0 0.8 0.6 -2 0.4 -4 0.2 -6 0.0 CY05 y/y % chg. -8 CY 05 Notes: 1. In the left chart, figures for issuance yields for CP up to September 2009 are the averages for CP (3-month, rated a-1 or higher). Those from October 2009 are the averages for CP (3-month, rated a-1). Figures for issuance yields for corporate bonds are the averages for domestically issued bonds launched on a particular date. Bonds issued by banks and securities companies, etc., are excluded. Figures for bank lending rates and issuance yields for corporate bonds show 6-month backward moving averages. Notes: 2. In the right chart, figures for lending by domestic commercial banks are monthly averages. Figures for CP and corporate bonds are those at the end of period. Sources: Bank of Japan; Japan Securities Depository Center; Capital Eye; I-N Information Systems; Japan Securities Dealers Association; Bloomberg. 11 ■
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Speech by Mr Hitoshi Suzuki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kumamoto, 29 August 2019.
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August 29 , 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kumamoto Hitoshi Suzuki Member of the Policy Board (English translation based on the Japanese original) I. Recent Economic and Price Developments A. Developments in Overseas Economies I would like to begin my speech by talking about overseas economies. Overseas economies have been growing moderately on the whole, although the business sentiment of manufacturing firms has begun to deteriorate in advanced economies in particular, amid protectionist trade policy in some countries and the heightening of geopolitical risks, as well as the accompanying uncertainty regarding global financial markets. Slowdowns are expected to continue for the time being, but overseas economies are likely to grow moderately on the whole thereafter with the growth rates rising somewhat, partly due to the effects of economic stimulus measures, such as in China, and the progress in global adjustments in IT-related goods. Let me take a look at developments by major region. Regarding the U.S. economy, while trade friction, particularly with China, seems to have been having a negative effect on momentum in manufacturing firms, nonmanufacturing firms have been showing resilience. In a favorable employment and income situation, the economy is likely to maintain its moderate expansion, partly underpinned by expansionary fiscal measures, as the Federal Reserve has implemented monetary policy measures that take into consideration the downside risks to economic activity and prices. The European economy has been decelerating, as seen, for example, in the slowdown in the pace of increase in business fixed investment with heightened uncertainty over economic and political developments. Potential downside risks to economic activity are trend changes in global financial markets, geopolitical developments, and considerable uncertainty over political developments, such as the outcome of negotiations on the United Kingdom's exit from the European Union (EU). The Chinese economy has continued to see stable growth on the whole, but some weakness has been observed in manufacturing firms. An estimate by the International Monetary Fund (IMF) suggests that, if the U.S.-China trade friction intensifies, the growth rate of the Chinese economy for 2020 could slow by around 1 percent. Although uncertainty remains, if trade friction with the United States heads toward a settlement, the stability of the economy is likely to be enhanced further as there is growing expectation that the authorities' stimulus measures gradually will take effect. Emerging economies other than China and commodity-exporting economies are likely to continue their moderate recovery on the whole. The view that global growth rates will rise somewhat is consistent with the forecasts of international institutions. For example, according to the July 2019 World Economic Outlook Update released by the IMF, global growth is forecast at levels exceeding 3.0 percent for 2019 and 2020, although the projections for both years were revised downward from those made in April 2019 (Chart 1). B. Current Situation of Japan's Economy I will now discuss the economic situation in Japan. Japan's economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, and the output gap has remained positive. In 2018, the real GDP growth rate for the July-September quarter was negative, due mainly to the effects of natural disasters. Thereafter, however, the rate registered positive growth for three consecutive quarters (Chart 2). Although exports, production, and business sentiment have been affected by the slowdown in overseas economies, the situation does not yet indicate an economic downturn, owing in part to a sustained increasing trend in business fixed investment. Private consumption has been increasing moderately, albeit with fluctuations, against the background of an improvement in the employment and income situation. However, careful attention is warranted on future developments, including those prior to and after the consumption tax hike scheduled for October 2019. According to the Regional Economic Report released by the Bank of Japan in July 2019, all nine regions of Japan reported that their respective economies had been either expanding or recovering (Chart 3). The Kyushu-Okinawa region, in which Kumamoto Prefecture is located, reported that firms' business sentiment generally remained at favorable levels, although exports and production were relatively weak on the whole. Housing investment and public investment were at high levels, and business fixed investment was increasing. Private consumption was also increasing moderately on the back of an improvement in the employment and income situation. Labor market conditions have remained tight as Japan's economy has maintained its expanding trend. The unemployment rate has been at a low level of around 2.5 percent, and the active job openings-to-applicants ratio has remained at a high level. Firms' perception of a labor shortage, suggested by the diffusion index for employment conditions in the June Tankan (Short-Term Economic Survey of Enterprises in Japan), remained at a high level in a wide range of industries (Chart 4). Firms in many industries therefore have been proceeding proactively with labor-saving investment with a view to utilizing artificial intelligence (AI), robotic process automation (RPA), and other technologies. In addition to developing a working environment that further encourages the labor participation of senior citizens and women, innovations in areas such as automation and labor-saving technologies are important for the social development of our economy in dealing with demographic changes brought about by an aging population. Experience suggests that, once this type of business fixed investment begins, including that intended for domestic capacity expansion, firms will also proactively consider renewing other plants and equipment, thereby making it unlikely that demand for fixed investment will decline significantly even in the presence of some uncertainty regarding the economy. Indeed, despite previous concern over a drop in business fixed investment, the real GDP growth rates for the January-March and April-June quarters of 2019 actually registered quarter-on-quarter increases. This could be regarded as an indication of the resilience of Japan's economy to downward pressure and uncertainties arising from overseas economies. C. Outlook for Japan's Economy Japan's economy is likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021. In fiscal 2019, exports are projected to continue showing some weakness for the time being, reflecting the effects of the slowdown in overseas economies, and the pace of increase in business fixed investment is likely to decelerate temporarily, mainly in manufacturing. On the other hand, private consumption likely will increase as the employment and income situation continues to improve. After the consumption tax hike scheduled for October, private consumption and housing investment are likely to be pushed down for some time. However, the rate of increase in business fixed investment is expected to rise somewhat, due in part to increases in investment related to urban redevelopment projects as well as labor-saving investment. Public investment is also likely to increase, due mainly to the implementation of the supplementary budgets for fiscal 2018 and the promotion of policy measures for national resilience. Moreover, exports are projected to return to their moderate increasing trend, with overseas economies growing moderately on the whole. Following a likely decline in the second half of fiscal 2019 due to the effects of the consumption tax hike, private consumption and housing investment are expected to head gradually toward a recovery in fiscal 2020. The economy is projected to be underpinned mainly by the continued increasing trend in exports, with the growth rates of overseas economies rising, and an expansion in public expenditure accompanying the hosting of the Olympic Games to be held in Tokyo in 2020. Japan's economy is therefore expected to continue on an expanding trend in fiscal 2020. Moreover, although Olympic Games-related expenditure will have been completed, private consumption and housing investment are projected to increase in fiscal 2021, partly because the effects of the decline in reaction to the scheduled consumption tax hike are likely to dissipate. Meanwhile, exports are projected to continue their moderate increasing trend, and business fixed investment is also likely to maintain its moderate uptrend, due in part to a rise in the potential growth rate. According to the Bank's July 2019 Outlook for Economic Activity and Prices (Outlook Report), the medians of the Policy Board members' forecasts for the real GDP growth rate are 0.7 percent, 0.9 percent, and 1.1 percent for fiscal 2019, 2020, and 2021, respectively (Chart 5). However, in considering the outlook for Japan's economy, attention should be paid to considerable uncertainties regarding the global economy. Specifically, these include U.S. protectionist moves and responses by its trading partners, developments in negotiations on the United Kingdom's exit from the EU, geopolitical risks in regions such as the Middle East and consequent fluctuations in crude oil prices, and the risk of a sharp decline in economic activity in Europe and China. Moreover, concerns over these risks may give rise to volatility in financial markets, which in turn would likely push down the global economy. Given these growing downside risks concerning overseas economies in particular, it is necessary to pay close attention to developments in firms' and households' sentiment in Japan. D. Prices in Japan Next, I will elaborate on price developments in Japan. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food (core CPI) has been at around 0.5 percent recently (Chart 6). With the price stability target set at 2 percent, the Bank has been conducting large-scale monetary easing, but there is still some way to go before achieving the target. However, firms have been raising prices of a wider range of products recently, and the output gap, which I will touch upon later, has remained positive. As these factors suggest, the conditions necessary for strengthening the movement toward price rises in the medium term have begun to be put in place, and thus the momentum toward achieving the price stability target appears to have been maintained in Japan. I would now like to explain the recent environment surrounding prices from the following three aspects: human resources, tangible factors such as capital equipment, and intangible factors including services prices. 1. Human resources Let me first explain the environment surrounding prices from the aspect of human resources. As I mentioned earlier, Japan's employment situation continues to be tight, as seen in such indicators as the unemployment rate and active job openings-to-applicants ratio; it seems that the labor market has been close to full employment. In such circumstances, wages are expected to rise. Wages have indeed been increasing, particularly for part-time employees and temporary workers. However, according to the press release presenting the results of the annual spring labor-management wage negotiations in 2019, as compiled by the Japanese Trade Union Confederation (Rengo), the year-on-year rate of increase in wages of Rengo union members, including the amount equivalent to regular pay hikes, remained at around 2.0 percent -marking the same level as that of 2018. Likewise, while base pay has risen for a sixth consecutive year, the negotiation results of firms for which base pay data were available for aggregation showed that the rate of increase was limited to around 0.5 percent. Moreover, the Japan Business Federation (Keidanren) revealed that the 2019 summer bonus payments of large firms fell below those of the previous year for the first time in two years. Given the projected decline in Japan's labor force, there is a risk of labor shortages intensifying. Thus, firms are expected to invest in their human resources wherever necessary through more proactive wage increases, so as to maintain their production levels. Through such wage increases, the virtuous cycle from income to spending will be enhanced, and inflation expectations of households and firms will rise. 2. Tangible factors Next, I will explain the tangible factors that affect prices. The Bank estimates the output gap, which is the economic measure of the difference between aggregate demand (actual output) of the economy and average supply capacity (potential output) that is smoothed out for the business cycle. According to this estimate, the output gap has remained positive for 10 consecutive quarters since the October-December quarter of 2016, due to the contribution of the tangible factor of a rise in capital utilization rates, in addition to the human resources factor of the steady tightening of labor market conditions, which I explained earlier (Chart 7). This suggests that capital utilization also has been exerting upward pressure on prices. 3. Intangible factors Lastly, in explaining the intangible factors that affect prices, such as the cost of services, I would like to touch on communication charges for mobile phones and the so-called koto consumption. This type of consumption is based on intangible qualities, and consumers seek value in experiences rather than getting pleasure merely from possessing material goods. These factors have been drawing attention recently. First, as communication charges for mobile phones in Japan have been weighing heavily on consumers, the government has requested mobile carriers to lower such charges, and the Cabinet has decided on a revision of the service plans that package handset payments and communication fees. Successive offers of new simpler plans by mobile carriers based on such revision have been pushing down the CPI as a result. Next, as for koto consumption, accommodation and overseas package tours are also consumption components that affect overall prices. In these areas, there is rising demand for koto consumption, and an increasing number of new services are being provided that primarily target tourists from abroad, in addition to domestic consumers. Given that the Olympic Games will be held in Tokyo, it is expected that price increases through such experience-oriented consumption also will contribute to pushing up prices overall. I have explained the recent environment surrounding prices from these three aspects -- human resources, tangible factors, and intangible factors. Needless to say, there are factors other than these that could affect prices. Despite current economic expansion and tight labor market conditions, the trend inflationary pressure on the CPI has remained relatively weak. This has been affected by the deeply entrenched mindset and behavior based on people's assumption that wages and prices will not increase easily, due mainly to the experience of prolonged low growth and deflation. Firms' efforts to absorb the increase in wage costs by raising productivity and technological progress in recent years, as seen in the expansion of online shopping, also have contributed to the situation where prices do not increase easily. Furthermore, consumers now face the important question as to how they can prepare for a 100-year lifespan. Reflecting these various factors, households' and firms' medium- to longterm inflation expectations are more or less unchanged (Chart 8). Inflation expectations are influenced by both the backward-looking (or adaptive) component that reflects past rates -i.e., the observed inflation rate -- and the forward-looking component that reflects the progress in the Bank's pursuit of monetary easing through its strong commitment to achieving the price stability target. Thus, a rise in prices is the key to increasing medium- to long-term inflation expectations, and it is important that this brings about a change in the perception of firms and households regarding future prices. E. Outlook for Prices in Japan Based on the three aspects that affect prices, the year-on-year rate of change in the CPI is likely to increase gradually toward the price stability target, as the effects of the current largescale monetary easing gradually permeate the economy. Firms are expected to broaden their efforts to raise prices and wages as Japan's economy continues on an expanding trend and the positive output gap is maintained, thereby inducing a gradual change in firms' and households' mindsets. Specifically, the medians of the Policy Board members' forecasts for the year-onyear rate of change in the core CPI presented in the July 2019 Outlook Report are 1.0 percent, 1.3 percent, and 1.6 percent for fiscal 2019, 2020, and 2021, respectively (Chart 5). However, it should be borne in mind that, if risks to economic activity materialize -- particularly those concerning overseas economies -- there is the possibility that prices will be affected to some extent. II. Conduct of Monetary Policy A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control Let me now turn to the Bank's monetary policy. Following the introduction of QQE in April 2013, the Bank has been pursuing QQE with Yield Curve Control since September 2016 toward achieving the price stability target of 2 percent. Under this policy framework, controlling short- and long-term interest rates -- the so-called yield curve control -- facilitates the formation of the term structure of interest rates that is most appropriate for achieving the price stability target. Specifically, in the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and decides to purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent (Chart 9). Thereafter, in July 2018, the Bank implemented measures to enhance the sustainability of QQE with Yield Curve Control. Specifically, in terms of yield curve control, while maintaining the target level of 10-year JGB yields at around zero percent, the Bank made clear that yields might "move upward and downward to some extent mainly depending on developments in economic activity and prices," thereby securing a certain degree of flexibility in the guideline for market operations. Under the framework of QQE with Yield Curve Control, Japan's economy has continued on an expanding trend and the output gap has remained positive. As for prices, the underlying trend in the year-on-year rate of change in the CPI excluding fresh food and energy has been generally in positive territory for six years. With regard to inflation expectations, the results of the Bank's June 2019 Opinion Survey on the General Public's Views and Behavior showed that, while medium- to long-term expectations remained low, the proportion of respondents who answered that prices would go up one year from now has increased recently, and this indicates a change in people's perception of future prices (Chart 10). Although there is still some way to go for the core CPI to increase toward the price stability target of 2 percent, it is crucial to resolutely continue with powerful monetary easing under QQE with Yield Curve Control. Under these circumstances, in April 2019, the Bank partially revised the description of forward guidance for policy rates to, "the Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike." This was to make clearer the Bank's policy stance that it will resolutely continue with powerful monetary easing toward achieving the price stability target (Chart 11). The statement released after the Monetary Policy Meeting held on July 29 and 30 specified that "the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost." This was to affirm the Bank's commitment to preempting any loss of momentum toward achieving the price stability target, particularly where -- mainly arising from developments in overseas economies -- there are significant downside risks to economic activity and prices. On this basis, should the Bank be required to examine and implement specific additional easing measures, it will take appropriate action depending on the situation while weighing the positive effects and side effects. B. Effects and Side Effects of Monetary Easing under a Low Interest Rate Environment Let me now share my views on the effects and side effects of monetary easing. While recognizing the importance of maintaining the extremely low levels of short- and longterm interest rates toward achieving the price stability target, it also is necessary to pay attention to the possibility of monetary easing effects materializing in an unusual manner and of the potential side effects. First, speaking of monetary easing effects, there is likely a zero lower bound on financial institutions' interest rates on deposits and loans, due to contractual and operational constraints. Meanwhile, it has been pointed out that, in the corporate bond market, the conventional method of deciding interest rates on corporate bonds by adding spreads to JGB yields has become less common amid negative JGB yields; instead, pricing is starting to be conducted by attaching greater importance to a positive fixed value of interest rates on corporate bonds rather than the relative relationship with JGB yields. In such a situation, with a virtually zero lower bound, there is the possibility that monetary easing effects stemming from an additional decrease in JGB yields will be more limited than before. Next, I would like to discuss three points arising from the potential side effects of monetary easing. The first point concerns financial institutions' risk-taking stance. With the population and the number of firms across regions declining, in addition to the current prolonged low interest rate environment, financial institutions' average contract interest rates on new loans have reached extremely low levels, owing in part to intensified competition among such institutions. In this situation, their core profitability has continued to be on a downtrend. There also is increasingly limited room to realize gains on the sales of securities and to reverse the allowance for doubtful accounts. As a result, financial institutions have been actively extending loans to middle-risk firms with relatively high credit risk and investing in assets such as foreign bonds and domestic and foreign investment trusts. The following points therefore warrant attention: a deterioration in the profitability of borrowing firms is more likely to result in an increase in credit costs in the event of a phase shift in economic developments and credit cycles, and the profits and soundness of financial institutions seem to have become significantly susceptible to developments in domestic and foreign financial markets. Second, if interest rates decline excessively, the narrowing of financial institutions' deposit and lending margins may make them unable to secure adequate profits, and through the tightening of their capital constraints, this could induce a decline in the amount of bank loans. Interest rate levels that reverse the effects of monetary easing in this way are known as "reversal rates." Third, if lending rates decline further, financial institutions that are no longer able to withstand increased downward pressure on their profits may start to charge fees and commissions on deposits, thereby making deposit rates virtually negative. In this case, some firms may prefer to proceed with debt repayment in an effort to reduce their deposits, and this could contribute to a decline in the amount of bank loans. Furthermore, if deposit rates fall into virtually negative territory, this could have an adverse effect on economic activity through a deterioration in consumer sentiment. When conducting monetary policy, the Bank must weigh up the positive effects against the accompanying costs and side effects, including the ones I have explained. In considering the effects of monetary policy, it is important to maintain a transmission channel through which monetary easing effects spread to the overall economy via financial institutions. Therefore, it is crucial that the Bank, while aiming to achieve price stability, also secure financial system stability so as to ensure that financial institutions can continue to fully perform their financial intermediation function. As the global financial crisis revealed, the considerable impact on the real economy of financial system instability makes it increasingly important that the Bank conduct monetary policy in a manner that focuses not only on achieving price stability, but also on giving due consideration to financial system stability, on the premise that monetary policy influences broad areas of financial activity. In other words, once financial system destabilizes, it would be extremely difficult for the Bank to ensure price stability. I believe that, at least for now, financial institutions in Japan as a whole are resilient against stress in terms of both capital and liquidity, and financial system stability has been maintained. Indeed, as financial institutions have maintained their active lending stance, the year-on-year growth rate of loans outstanding has been in positive territory. Yet, going forward, the Bank must consider monetary policy measures more carefully, to prevent financial system instability. In doing so, it should examine closely the effects on the profits and lending stance of financial institutions of changes in their attitude to risk and of the current prolonged low interest rate environment, by taking into account not only the time frame in which monetary policy effects spread to the real economy, but also the time frame in which the side effects accumulate. As the Bank continues resolutely with the current monetary easing policy, it will conduct monetary policy in an appropriate manner, while examining all relevant risks, so that the momentum toward achieving the price stability target is maintained. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Kumamoto August 29, 2019 Hitoshi Suzuki Bank of Japan Chart 1 Global Economy IMF Projections (as of July 2019) Real GDP Growth Rate real GDP growth rate, y/y % chg., % points World 3.8 3.6 Advanced economies 2.4 2.2 United States 2.2 2.9 Euro area 2.4 1.9 United Kingdom 1.8 1.4 Japan 1.9 0.8 4.8 4.5 6.6 6.4 China 6.8 6.6 ASEAN 5.3 5.2 CY Emerging market and developing economies Emerging and developing Asia Russia 1.6 2.3 Latin America and the Caribbean 1.2 1.0 Avg. growth rate (1980-2018)： +3.5% projection projection 3.2 (-0.1) 1.9 (+0.1) 2.6 (+0.3) 1.3 (0.0) 1.3 (+0.1) 0.9 (-0.1) 4.1 (-0.3) 6.2 (-0.1) 6.2 (-0.1) 5.0 (-0.1) 1.2 (-0.4) 0.6 (-0.8) 3.5 (-0.1) 1.7 (0.0) 1.9 (0.0) 1.6 (+0.1) 1.4 (0.0) 0.4 (-0.1) 4.7 (-0.1) 6.2 (-0.1) 6.0 (-0.1) 5.1 (-0.1) 1.9 (+0.2) 2.3 (-0.1) Source: World Economic Outlook Update, International Monetary Fund (IMF). Note: Figures in parentheses are the difference from the April 2019 projections. y/y % chg. IMF projections -1 CY 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 24 Source: IMF. Chart 2 Japan's Real GDP s.a., ann., q/q % chg. s.a., q/q % chg. s.a., tril. yen Real GDP (nominal value, right scale) Q2 Q3 Q4 Q1 Q2 0.4 -0.5 0.4 0.7 0.4 Real GDP [ann., q/q] Private consumption 0.4 -0.1 0.4 0.1 0.6 -2 Private non-resi. investment 2.5 -2.6 2.7 0.4 1.5 Private residential investment -1.9 0.8 1.3 0.6 0.2 Public demand -0.2 -0.2 0.3 0.2 0.9 Exports of goods & services 0.8 -2.1 1.2 -2.0 -0.1 -4 Real GDP growth rate (left scale) -6 -8 -10 CY 2013/Q2 Q4 14/Q2 Q4 15/Q2 Q4 16/Q2 Q4 17/Q2 Q4 18/Q2 Q4 19/Q2 Source: Cabinet Office. Source: Cabinet Office. ［1.6］ [-1.9] [1.6] [2.8] [1.8] Regional Economic Assessments Chart 3 Comparison of Previous and Current Assessments by Region Changes from the previous assessment Region Assessment in April 2019 Hokkaido The economy has been recovering moderately. The economy has been recovering moderately. Tohoku The economy has continued to recover moderately, although some weakness has been observed in part. The economy has continued to recover moderately, although some weakness has been observed in part. Hokuriku The economy has been expanding moderately. The economy has been expanding moderately. KantoKoshinetsu The economy has been expanding moderately, although exports and production have been affected by the slowdown in overseas economies. The economy has been expanding moderately, although exports and production have been affected by the slowdown in overseas economies. Tokai The economy has been expanding. The economy has been expanding. Kinki The economy has continued to expand moderately. The economy has continued to expand moderately, although some weakness has been observed in part. Chugoku The economy has been expanding moderately. The economy has been expanding moderately. Shikoku The economy has been recovering. The economy has been recovering. KyushuOkinawa The economy has been expanding moderately. The economy has been expanding moderately. Source: July 2019 Regional Economic Report, Bank of Japan. Assessment in July 2019 Chart 4 Labor Market Conditions Unemployment Rate and Active Job Openings-to-Applicants Ratio 1.8 s.a., ratio s.a., % Diffusion Index (DI) for Employment Conditions reversed, DI ("excessive employment" minus "insufficient employment"), % points 1.6 -80 -60 1.4 Insufficient employment All industries Manufacturing Construction Retailing Accommodations, eating & drinking services -40 1.2 -20 1.0 0.8 0.6 0.4 Active job openings-to-applicants ratio for full-time employees (left scale) Active job openings-to-applicants ratio (left scale) Unemployment rate (right scale) 0.2 0.0 CY 2005 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Excessive employment CY 2005 Source: Tankan (Short-Term Economic Survey of Enterprises in Japan), Bank of Japan. Chart 5 Outlook for Economic Activity and Prices as of July 2019 Forecasts of the Majority of Policy Board Members y/y % chg. Real GDP CPI (all items less fresh food) +0.6 to +0.9 +0.8 to +1.1 [+0.7] [+1.0] +0.7 to +0.9 +0.9 to +1.2 [+0.8] [+1.1] +0.8 to +1.0 +1.1 to +1.4 [+0.9] [+1.3] +0.8 to +1.1 +1.2 to +1.5 [+0.9] [+1.4] +0.9 to +1.2 +1.3 to +1.7 [+1.1] [+1.6] +0.9 to +1.2 +1.4 to +1.7 [+1.2] [+1.6] Fiscal 2019 Forecasts made in April 2019 Fiscal 2020 Forecasts made in April 2019 Fiscal 2021 Forecasts made in April 2019 Source: July 2019 Outlook for Economic Activity and Prices, Bank of Japan. Notes: 1. Figures in brackets indicate the medians of the Policy Board members' forecasts (point estimates). 2. The forecasts assume the following: (1) the consumption tax will be raised to 10 percent in October 2019 and a reduced tax rate will be applied to food and beverages -- excluding alcohol and dining out -- and newspapers, and (2) with regard to policies concerning the provision of free education, free early childhood education and such measures as free higher education will be introduced in October 2019 and April 2020, respectively. Chart 6 CPI s.a., y/y % chg. 2.0 All items less fresh food (core CPI) 1.5 All items less fresh food and energy 1.0 0.5 0.0 -0.5 -1.0 CY 2013/Apr. Oct. 14/Apr. Oct. 15/Apr. Oct. 16/Apr. Source: Ministry of Internal Affairs and Communications. Note: Figures are adjusted for the effects of consumption tax hikes. Oct. 17/Apr. Oct. 18/Apr. Oct. 19/Apr. Chart 7 Output Gap 2.5 % 2.0 Excess demand (upward pressure on prices) 1.5 1.0 0.5 0.0 -0.5 -1.0 Excess supply (downward pressure on prices) -1.5 CY 2013/Q1 Q3 14/Q1 Q3 Source: Bank of Japan. Note: Based on staff estimations. 15/Q1 Q3 16/Q1 Q3 17/Q1 Q3 18/Q1 Q3 19/Q1 Chart 8 Inflation Expectations 2.5 y/y, ann. avg., % Households (over the next five years) 2.0 Firms (five years ahead) 1.5 1.0 0.5 0.0 CY 2005 Source: Bank of Japan. Notes: 1. Figures for households are from the Opinion Survey on the General Public's Views and Behavior, estimated using the modified Carlson-Parkin method. 2. Figures for firms are from the Tankan (General Prices, summary of "Inflation Outlook of Enterprises," all industries and all enterprises). Chart 9 Yield Curve Control 1.2 % 1.0 Target level of the long-term interest rate: around zero percent 0.8 0.6 0.4 Short-term policy interest rate: minus 0.1 percent 0.2 0.0 -0.2 residual maturity, year Chart 10 Outlook for Price Levels % Prices will go up one year from now Prices will go up over the next five years CY 2013/Mar. Sept. 14/Mar. Sept. 15/Mar. Sept. 16/Mar. Sept. 17/Mar. Sept. 18/Mar. Sept. 19/Mar. Source: Opinion Survey on the General Public's Views and Behavior, Bank of Japan. Notes: 1. Disregarding the effects of consumption tax hikes. 2. Figures for both comprise respondents who chose either "will go up significantly" or "will go up slightly" in the questionnaire. Chart 11 Strengthening the Framework for Continuous Powerful Monetary Easing Persistently Continuing with Powerful Monetary Easing Likely to take time to achieve the price stability target of 2% Forward guidance for policy rates "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the consumption tax hike." ” Yield curve control and ETF purchases Appropriate to maintain the positive output gap for as long as possible The long-term interest rate: The Bank will purchase JGBs so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. ETF purchases: The Bank will purchase ETFs so that their amount outstanding will increase at an annual pace of about 6 trillion yen. The Bank may increase or decrease the amount of purchases depending on market conditions. Achieving the price stability target of 2% at the earliest possible time while securing stability in economic and financial conditions
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the FIN/SUM 2019, Tokyo, 4 September 2019.
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September 4, 2019 Bank of Japan Integrating Finance and Technology for New Growth Opportunities Remarks at the FIN/SUM 2019 Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction I am delighted to be given this opportunity to speak to you at the FIN/SUM 2019. The main theme of this year's FIN/SUM is "new sources of growth." The key to raising economic growth is to stimulate potential needs and further provide goods and services for which people are willing to pay. According to Schumpeter, firms need to make innovation that leads to the introduction of a new good and the opening of a new market. In recent years, there has been a growing interest in FinTech. It has been driven by the dramatic evolution of information technology, but this is not the only factor. Financial services that did not exist before have been created by information technology. As these services have been met with high demand by the public and have begun to transform the way of living, FinTech is drawing more attention. Typical examples include financial services using smartphones. Smartphones are palm-sized computers that enable cashless payments and internet banking services. However, they are not just a payment tool. Integrating payment functions with digital marketing and search functions helps create new demands, improving the convenience of services. Smartphones enable us to pay train fares, pick up and pay for taxis, and search for and purchase goods. Incorporating payment tools into a range of commercial services provides new added value. The Role of the Banker Schumpeter is well known for highlighting the importance of innovation for economic growth in his book, The Theory of Economic Development. He also mentions the role of the "banker" in economic development. The process of "creative destruction," as defined by Schumpeter, begins with an attempt by visionary entrepreneurs to innovate. Namely, they do so through the introduction of a new good, the introduction of a new method of production, the opening of a new market, the conquest of a new source of supply of raw materials, and the carrying out of a new organization of any industry. The banker then evaluates entrepreneurs' potential and provide finance to support their innovations, which facilitates economic development. The banker searches for entrepreneurs who can create innovative businesses and select the most promising ones. Competition among bankers to find skillful entrepreneurs contributes to improvements in the efficiency of their operations, thereby increasing their profits. Such behavior of the banker helps achieve efficient resource allocation from a macroeconomic perspective, which endogenously enhances economic growth. The banker discussed here is not confined only to the literal meaning of a banker. They include investors such as venture capitalists who have an eye for assessing the businesses and risks of startups. The role of capital markets, including stock and corporate debt markets, would also be considered as the banker in a broad sense. Moreover, FinTech firms have begun to partly play the role of what Schumpeter calls a "banker" in recent years. Let me explain in more detail. Taking Advantage of Corporate Payments and Commercial Information As discussed, a range of commercial and financial services are now provided in an integrated manner with smartphones. Commercial and financial functions are closely linked and inseparable; this has not changed since the olden days. As banks used to provide credit mainly by discounting commercial bills, lending services were essentially incorporated into commercial businesses. That is, banks engaged in payment services with access to commercial information, which enabled them to provide credit efficiently to the economy. Given payment information is derived from commercial information, the latter is more fundamental than the former. Clients' commercial information is the key to better assessing their creditworthiness. In other words, ensuring access to fundamental commercial information enables even nonbanks to gain a competitive advantage in information production, and perform financial intermediation functions. Indeed, FinTech firms, including accounting software vendors, have started accumulating corporate commercial and payment information in recent years. A chronic labor shortage in Japan has facilitated the introduction of accounting software in the corporate sector to streamline the bookkeeping process. With clients' consent, FinTech firms such as accounting software vendors can access granular payment and commercial information in an efficient and instant manner. In addition, artificial intelligence and machine learning technologies help analyze data to assess clients' creditworthiness. A wider access to clients' commercial and payment information by FinTech firms has led to the recent expansion of transaction lending businesses. Schumpeter describes innovation as "new combinations" in his original book. FinTech firms have literally achieved a "new combination" as "entrepreneurs" by incorporating accounting information processing, and credit information production, to provide transaction lending services. This new combination helps establish efficient lending frameworks that reduce costs for credit assessment, shorten screening processes, and improve the performance of credit risk models. In the meantime, meeting the demand for loans from clients is a challenge for some FinTech firms that do not have sufficient funding sources. In this regard, financial institutions can cooperate with FinTech firms by providing funding. This helps financial institutions ensure new growth opportunities by finding new clients with whom no business deal was previously made because of the profitability of the deal. These initiatives also bring opportunities for startups and small and medium-sized enterprises (SMEs) with insufficient collateral and guarantee capacity to expand their businesses. If FinTech firms and financial institutions -- which have a comparative advantage in information production and fund provision respectively -- work together to play the role of the "banker," that could result in better financial services. This would be a good example of new growth opportunities within the context of financial intermediation. Conclusion The Bank of Japan established the FinTech Center to facilitate the development of FinTech in 2016, the year when the FIN/SUM first took place. The topic of corporate payments and commercial data utilization, for example, has been discussed with a wide range of experts at our FinTech Forum as well and we have released the insights and perspectives gained from the discussion on our website. The Bank will continue to make efforts so that better financial services and the creation of new businesses will lead to economic growth. In this year's FIN/SUM, we welcome a rich variety of participants, including those from the financial and technology sectors. I sincerely hope that interactions between the participants will lead to "new sources of growth" -- which is the theme of this year's FIN/SUM. Thank you for your attention.
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Speech by Mr Goushi Kataoka, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate, 4 September 2019.
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September 4, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Hakodate Goushi Kataoka Member of the Policy Board (English translation based on the Japanese original) I. Economic Activity and Prices A. Overseas Economies I would like to start my speech by looking at developments in overseas economies. With the growth pace of the global economy slowing since the second half of 2018, differences in growth rates among countries are evident, and some risk factors have started to materialize. According to the July 2019 World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF), as presented in Chart 1, the global economic growth rate is projected to decelerate to 3.2 percent in 2019, picking up to 3.5 percent in 2020. However, downward revisions from the April 2018 WEO forecasts are evident, as seen on the right-hand side of Chart 1. As for the global Purchasing Managers' Index (PMI), shown in Chart 2, the index for manufacturing has been below the neutral 50-point level for two consecutive months, marking the lowest level since October 2012, when the global economy faced the European sovereign debt crisis. The index for services is on a moderate declining trend, although it is still above the 50-point level. Given these facts, I suppose there is a growing possibility that the recovery in the global economy, which was expected to start from the second half of 2019, may be delayed, and the degree may be limited. There are three specific key factors behind my thoughts: (1) the heightening of economic policy uncertainty; (2) developments in the U.S.-China trade friction and their effects; and (3) the outlook for the world semiconductor market. With regard to the first factor, Chart 3 presents the year-on-year rate of change in global production and the Global Economic Policy Uncertainty Index, which shows the GDP-weighted average of economic policy uncertainty levels for 20 major countries. The pace of increase in global production is decelerating while uncertainty over economic policy conducted by each country is heightening. The second factor is developments in the U.S.-China trade friction, which is particularly crucial among various economic policy uncertainties. Chart 4 shows the impact of the trade friction on GDP for the United States and China, estimated by the IMF in June 2019. The left-hand bar graph represents the deviations from baseline projections of the real GDP levels for the two countries. The simulations take into account the tariff hike from 10 percent to 25 percent on 200 billion dollars' worth of U.S. imports from China as of May 8, 2019, and assume an envisaged 25 percent tariff on the remaining U.S. imports from China as well as retaliation by China. Although the impact differs between the two countries in the short run, the trade friction will equally exert downward pressure on real GDP in both countries by around 0.4 percent in the long run. The right-hand chart shows the impact of the trade friction on the global economy. The tariff hikes implemented in 2018 are exerting downward pressure on global real GDP for 2019 by more than 0.2 percent. If the 25 percent tariff is imposed on almost all items imported from China, it is estimated that the global real GDP figures for 2019 and 2020 will be pushed down by around 0.4 percent and 0.5 percent, respectively. The United States recently announced that it will impose additional tariffs on the remaining imports, worth approximately 300 billion dollars, and will raise tariffs by 5 percentage points on the U.S. imports from China that already have been taxed. As trade negotiations have not come to a conclusion, attention should continue to be paid to the fact that the global economy still faces downside risks. The third factor is the outlook for the world semiconductor market. Deceleration in world semiconductor sales became notable from mid-2018. Various reasons have been pointed out as the background to this; for example, a halt in expansion of demand for data centers, a prolonged replacement cycle for smartphones, and a decline in business fixed investment related to machine tools -- which largely are equipped with semiconductors -- due mainly to deterioration in the U.S.-China trade friction. The left-hand side of Chart 5 compares the forecasts for the year-on-year growth rate in the semiconductor market made by the World Semiconductor Trade Statistics Inc. in autumn 2018 and spring 2019 by region. The forecasted market growth rate for 2019 has been revised sharply downward in the spring 2019 forecast, from a slight increase in the autumn 2018 forecast, especially for the U.S. market. The right-hand chart shows the year-on-year rate of change in world semiconductor shipments. As the pace of increase in shipments was fast over the past two years, recovery in the semiconductor market likely will take time. B. Japan's Economy Next, I would like to turn to Japan's economy, starting with recent developments. In Chart 6, the line graph shows developments in the real GDP growth rate and the bar graph shows the contribution of each component to GDP. The growth rate for the July-September quarter of 2018 registered negative growth, due mainly to the effects of natural disasters, but subsequently has been positive for three consecutive quarters through the April-June quarter of 2019. In that quarter, the contribution of exports remained small, reflecting the slowdown in the global economy, but the contribution of domestic demand turned positive due to an increase in the contribution of private consumption, business fixed investment, and government spending, which had decreased in the previous quarter. Overall, the increase in domestic demand more than offset the decrease in external demand in the April-June quarter. Turning to the outlook for Japan's economy, as shown in Chart 7, the medians of forecasts made by the Bank of Japan's Policy Board members for real GDP growth rates presented in the July 2019 Outlook for Economic Activity and Prices (Outlook Report) are 0.7 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.1 percent for fiscal 2021. The Bank's baseline scenario is that, although external demand is likely to be somewhat weak for the time being, it gradually will increase thereafter, and with the firm domestic demand, the economy is likely to continue on an expanding trend. However, my projection for fiscal 2019-2021 is around 0.5 percent to 1.0 percent, which is slightly below the potential growth rate. I also am of the view that risks to economic activity are tilted to the downside. As background to my projection, I consider that an important factor is how the deterioration in external demand will affect domestic demand. In the following, I will explain my views on exports, business fixed investment, and private consumption. First, real exports turned to a decline in the January-March quarter of 2019 and experienced weak recovery in the following quarter, as seen in Chart 8. The key to the outlook is developments in the U.S.-China trade friction and the degree of recovery in the semiconductor market, and I believe that real exports are highly likely to remain sluggish for the time being. Second, business fixed investment has been on an uptrend, with insufficient capacity -- as shown in Chart 9 -- continuing to exert upward pressure on investment. However, according to the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion index (DI) for production capacity has been approaching the turning point between insufficient and excessive capacity since the turn of 2019, and my view is that the increasing trend in business fixed investment may come to a halt. Business fixed investment plans in the June 2019 Tankan were firm on the whole, both in manufacturing and nonmanufacturing. As shown in Chart 10, however, within manufacturing, investment plans of the processing industries, which are highly dependent on exports -- such as the general-purpose, production, and business oriented machinery, as well as the motor vehicles industries -- were below the past average. In particular, investment plans of the general-purpose, production, and business oriented machinery industries were revised downward in the June survey from the March survey. The recent growth in the plans of overall manufacturing is driven by the basic materials industry, but considering the past average of revision patterns in the Tankan, the investment plans of the basic materials industry also may be revised downward. Furthermore, as for nonmanufacturing, shown in Chart 11, investment plans of the construction as well as the wholesaling and retailing industries were at about the same levels as the past average, but those of the information communication industry were relatively weak. Thus, although business fixed investment plans are firm on the whole, I think that those of manufacturing are being steadily influenced by the slowdown in overseas economies. Lastly, private consumption has been on a moderate increasing trend, driven by consumption of durable goods and services, as presented in Chart 12. This reflects the sustained favorable employment. However, there have been signs of changes in the labor market since the turn of 2019. For example, the employment-related level DI in the Economy Watchers Survey is at a level very close to falling below the neutral point of 50, and the number of active job openings has decreased for five consecutive months on a year-on-year basis. As Chart 13 indicates, developments in consumption have been moderate so far, although the consumption tax hike is coming up in October 2019, and I assume that consumer sentiment has deteriorated more than in the second half of fiscal 2013, half a year before the previous tax hike. It is difficult to predict how the measures to reduce the household burden of the tax hike will affect consumption, and thus attention should be paid to future developments in consumption, including the effects of the tax hike.1 C. Recent Developments and Outlook for Prices Next, I will move on to price developments. As indicated in the left-hand side of Chart 14, the year-on-year rates of increase in the consumer price index (CPI) for July 2019 both for all items less fresh food and for all items less fresh food and energy were 0.6 percent. Looking at the right-hand side of Chart 14, which shows indicators that represent the underlying developments in consumer prices, items for which prices have risen outnumber those for which prices have declined, and the difference between the two figures has been widening slightly since the turn of 2019. However, the rises in trimmed mean and weighted median have come to a halt, and it can be said that price rises have not spread to goods that have a high share in consumption. Next, I will take a look at developments in the output gap and medium- to long-term inflation expectations, which are indicators that influence underlying price developments. The output gap, as shown in the left-hand side of Chart 15, has remained positive, reflecting improvements in the capital stock and labor markets. Recently, however, it seems that it is no longer on an expanding trend. Inflation expectations have been somewhat weak, as The 2019 Salaried Worker Pocket Money Survey released by Shinsei Bank shows the results of a survey conducted of 2,700 workers, both male and female, aged 20 through 59 years. The respondents were asked "If the consumption tax is raised to 10 percent, will it be a burden on your pocket money?" For both men and women, the proportion of respondents who answered that the 10 percent tax "will be a great burden" was higher than that of those who answered that the current 8 percent tax "is a great burden." The proportion of those who answered that the 10 percent tax hike "will be a burden" (comprising the choices "will be a great burden" and "will slightly be a burden") was higher by more than 10 percentage points than that of those with the same answers for the current 8 percent tax. Furthermore, Hakuhodo Inc. revealed in its survey that 71.3 percent of respondents answered that the 10 percent tax hike "will be a heavier burden compared with the previous tax hike." The ratio was higher in particular for women aged 20 through 49 years. For details, see "Shōhi zei taisaku kenkyū purojekuto chōsa: Zōzei zen go no ishiki-kōdō," Hakuhodo Inc., June 2019. Taking account of the difficulties in projecting developments in consumption after the tax hike and of the time lag in releasing statistics, I consider that it has become more necessary than at the time of the previous tax hike to enhance analysis of real-time data. indicated in the right-hand side of Chart 15. I am convinced that this is attributable to the adverse effects of prolonged deflation in the past and to recent weak price developments. In addition, in my view, the credibility of achieving the Bank's 2 percent price stability target has not been sufficiently enhanced among the public, and this also is affecting inflation expectations. Turning to the outlook for prices, the medians of the Policy Board members' forecasts for the year-on-year rate of change in the CPI (all items less fresh food) presented in the July 2019 Outlook Report are 0.8 percent for fiscal 2019, 1.2 percent for fiscal 2020, and 1.6 percent for fiscal 2021, excluding the effects of the scheduled consumption tax hike and policies concerning the provision of free education (Chart 7). The Bank's view is that the momentum toward the 2 percent price stability target will be maintained. It cannot be judged, however, that the inflation rate will accelerate toward 2 percent, and thus I dissented from the relevant description in the July Outlook Report. There are four main reasons behind my position. First, a widening of the output gap is less likely to lead to a rise in inflation rates. Second, it takes some time for the adaptive formation mechanism to bring about an increase in inflation expectations and then lead to price rises.2 Third, in a situation where the monetary policy is unchanged amid successive downward revisions to the Bank's outlook for prices, it is unlikely that inflation expectations will rise in a forward-looking manner through an enhancement of the credibility that the price stability target will be achieved. Fourth, while overseas central banks are strengthening their monetary easing stance, the risk that circumstances surrounding Japan's prices are becoming more adverse, mainly through foreign exchange rates, is heightening. Ichiue et al. (2019) explain the possibility that the actual mechanism of expectation formation is more complicated than what the simple model of adaptive expectation formation indicates. On this basis, they introduce three hypotheses as the reason for inflation expectations not rising in Japan: inflation expectations that are dependent on the long period of individuals' experiences; (2) social norms that prices will not rise; and (3) "rational inattention." See, for details, Ichiue Hibiki et al., "Kinnen no infure dōgaku o meguru ronten: nihon no keiken," Bank of Japan Working Paper Series, no. 19-J-3, June 2019, https://www.boj.or.jp/research/wps_rev/wps_2019/data/wp19j03.pdf. II. Conduct of Monetary Policy Let me first outline the Bank's current monetary policy, based on the outlook for economic activity and prices that I have described. I would then like to express my opinion about the Bank's monetary policy conduct. The Bank conducts monetary policy under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the 2 percent price stability target. This current framework consists of three major components (Chart 16). The first is yield curve control, in which the Bank sets the short-term policy interest rate at minus 0.1 percent and the operating target for long-term interest rates at around 0 percent. As for long-term interest rates, the Bank purchases Japanese government bonds (JGBs) while allowing some degree of fluctuation in long-term yields, depending mainly on developments in economic activity and prices. The second component is the purchase of risk assets, including exchange-traded funds (ETFs). The Bank purchases ETFs so that their amount outstanding will increase at an annual pace of about 6 trillion yen. With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions. The third component is the Bank's public commitment regarding the future conduct of monetary policy. In April 2019, the Bank clarified forward guidance for policy rates, stating that it "intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike." The Bank aims to strengthen market confidence and expectations regarding the sustainability of monetary easing by making a commitment to the levels of future policy interest rates and the duration for maintaining low interest rates, in addition to the inflation-overshooting commitment regarding the monetary base. Of these three components, I dissented from two: yield curve control and the Bank's commitment regarding the future conduct of monetary policy. As presented in the joint statement by the Bank and the government, the Bank's mission is to achieve the price stability target at the earliest possible time. With this in mind, as for yield curve control, I judged it necessary to strengthen monetary easing in the situation where the observed inflation rate was still evidently far from the 2 percent price stability target. Based on such recognition, I pointed out that it was appropriate for the Bank to revise the forward guidance for the policy rates to relate it to the price stability target, in addition to encouraging a further widening of the output gap within positive territory through additional easing. 3 Moreover, to overcome deflation completely amid heightening uncertainties regarding economic and price developments, I considered it important to influence the expectations and forecasts of market participants as well as firms and households by implementing the appropriate means to further coordinate fiscal and monetary policy.4 At the July 2019 Monetary Policy Meeting, a new sentence was added at the end of the Statement on Monetary Policy: "In particular, in a situation where downside risks to economic activity and prices, mainly regarding developments in overseas economies, are significant, the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost." Amid increasing downside risks to economic activity and prices, and in the aforementioned Bearing in mind the current yield curve, which has flattened, I think that it is appropriate to conduct yield curve control so that its shape becomes more accommodative by setting a greater negative value for the short-term policy interest rate. In the event that the price stability target cannot be achieved through around spring 2020, which is the time frame given in the current forward guidance, it may need to be extended. In my opinion, it is not favorable for the Bank to make such changes repeatedly, as there is concern that public confidence regarding monetary policy could deteriorate. I consider it appropriate for the Bank to revise the forward guidance for the policy rates to relate it to the price stability target. 4 I would argue that the mindset of firms and households in Japan was formed under the prolonged deflationary environment after the mid-1990s, such that it has become rational to assume that economic activity is sustainable without inflation. In a situation where the anchor of inflation expectations has been lost, I believe that to achieve the 2 percent price stability target and maintain the target price level in a stable manner, it is important not only to enhance monetary easing, but also to further strengthen the coordination of fiscal and monetary policy -- that is, a "policy mix." current situation where the observed inflation rate is still evidently far from the 2 percent price stability target, it is important to make a preemptive policy response, not after confirming changes in the inflation rate which is a lagging indicator of economic conditions. The Bank will continue to make efforts toward overcoming deflation completely. III. Changes in Japan's Labor Market Next, I would like to talk about Japan's labor market. As shown in Chart 17, Japan's unemployment rate continued to rise throughout the 1990s and until 2002, when it marked 5.5 percent; it then declined to the 3 percent level but rose again following the failure of Lehman Brothers, and has dropped to the range of 2.0-2.5 percent recently.5 Despite such improvement in labor market conditions, the growth in wages and prices has been sluggish. As the background to this, various factors have been cited; for example, low wages of the "employment ice-age" generation, possible effects of the upward wage rigidity, the increasing share of part-time employees, and subdued demands by labor unions for wage increases.6 Some of these factors are based on the assumption that labor market conditions already have been tight. I now would like to review To explain the rise in the unemployment rate since the 1990s, researchers have conducted factor decomposition, concluded that a shortage in demand and structural changes in the labor market contributed to the rise, and then estimated the contribution. My estimation of the structural unemployment rate that measures structural changes in the labor market was in the range of 2.5-3.0 percent, as in Kataoka Goushi, "Kōzō shitsugyō ritsu suitei hōhō no ayamari," chap. 11 in Abenomikusu wa shinkasuru: Kin'yu ganseki riron o tou, ed. Harada Yutaka, Kataoka Goushi, and Yoshimatsu Takashi (Tokyo: Chuokeizai-sha, 2017). Recently, however, while the unemployment rate remains in the range of 2.0-2.5 percent, the pace of increase in wages has not accelerated. In estimating the structural unemployment rate, it is necessary to consider changes in demographics, the expansion in the labor force participation of seniors and women, and estimation methods and errors. 6 See Genda Yuji, ed., Hitode busoku na noni naze chingin ga agaranai no ka (Tokyo: Keio University Press, 2017). Ozaki and Genda (2019) analyzed the reason why wages had not shown a sharp increase by using the latest data, and concluded that wages, particularly of women, were likely to rise rapidly if the expansion of labor supply ended and the labor market for non-regular employees reached the Lewisian Turning Point. See Ozaki Tatsuya and Genda Yuji, "Chingin jyōshō ga yokusei sareru mekanizumu," Bank of Japan Working Paper Series, no. 19-J-6, July 2019, https://www.boj.or.jp/research/wps_rev/wps_2019/data/wp19j06.pdf. whether the current labor market conditions are so tight as to have reached a level that can encourage rises in wages and prices. In addition to the unemployment rate, Chart 17 shows developments in the labor force participation rate, which is the ratio of persons who want to work (labor force) among those in the population aged 15 years and over. The rate continued to decline from around 2000, bottomed out around end-2012, and has been rising since then. In October 1992, when the unemployment rate was 2.2 percent, the same level as in July 2019, the labor force participation rate was 64.2 percent, which is about 2 percentage points higher than that of July 2019. This implies the possibility that the labor market conditions are less tight now than in 1992. Needless to say, the advance in the aging of the population and the decline in the birthrate have exerted downward pressure on the labor force participation rate from 1992 to the present, and we should exclude such effects from our observations. Chart 18 indicates the results of the decomposition of factors that contributed to the overall change in the labor force participation rate from October 1992 to date. The demographic factor has pushed down the overall rate by a large margin with the aging of the population. On the other hand, the increase in the contributions of women (aged between 15 and 59 years) and of the elderly (men and women aged 60 years and over) gradually have pushed up the overall rate. Their positive contributions remained small until around end-2012 but have seen particular acceleration since then, substantially offsetting the negative contribution of the demographic factor. Firms' growing demand for labor, backed by the economic expansion, has encouraged those who had chosen not to work, mainly women and seniors, to join the labor force and has increased the number of workers, thereby causing the unemployment rate to decline. Nevertheless, the labor force participation rate of men (aged between 15 and 59 years) has not recovered to the level before the "lost two decades," and this may be a reason why labor market conditions are not tight enough to push prices upward.7 In order to better grasp the employment situation from various aspects, the Ministry of Internal Affairs and Communications started to include items related to labor underutilization and collected data from January 2018 in the Labour Force Survey, in addition to the previously compiled labor force status; that is, employed persons, unemployed persons, and persons not in the labor force.8 As shown in the right-hand side of Chart 19, labor underutilization consists of "persons in time-related underemployment," which are part-time employees who wish to work longer hours or full-time, including those who currently are working short hours due to employers' circumstances, such as the need to make production adjustments, (2) "unemployed persons," which are persons who have been seeking jobs within the previous one month and are ready to work as soon as a job becomes available, and (3) "potential labor force," which is comprised of those categorized neither as employed nor unemployed in the Labour Force Survey, potentially able to work because they are willing to do so, but did not seek jobs. The left-hand side of Chart 19 shows the ratio of such labor underutilization to the overall labor force including the potential labor force. This chart indicates that there is still room for a further decrease in unemployed male workers, as well as a further increase in working hours of female workers accomplished through such means as changing their employment status and environment. Nakagawa (2018) pointed out that a decline in the men's labor force participation rate pushed down the overall rate for 2017 by 0.6 percentage point compared with that for 1994, when the unemployment rate was about the same level as 2017. She then stated that about 700,000 additional workers would be needed to fill this gap. Considering the slack in labor supply of men, the unemployment rate level that can encourage rises in wages and prices was assumed to be about 2 percent. See Nakagawa Ai, "Rōdō jyukyū ga hippaku shitemo chingin to bukka ga agaranai no wa naze ka," chap. 2 in Abenomikusu no shinka, ed. Harada Yutaka and Masujima Minoru (Tokyo: Chuokeizai-sha, 2018). 8 For details, see Statistics Bureau, Ministry of Internal Affairs and Communications, Rōdō ryoku chōsa mikatsuyō rōdō shihyō no kaisetsu. An English translation of the summary is available in Revisions of the Labour Force Survey from January 2018, March 2018. In sum, labor market conditions will tighten further and wages and prices will rise if the following conditions are met: a rise in men's labor force participation rate, a decline in men's unemployment rate, and an increase in women's working hours. As I mentioned earlier, some signs of weakness have been observed in the labor market recently. Accelerating the pace of growth in aggregate demand is the key to preventing negative effects from spreading to the whole labor market. Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Hakodate September 4, 2019 Goushi Kataoka Member of the Policy Board of the Bank of Japan Chart 1 World Economic Outlook by the IMF Advanced Economies July 2019 forecasts (y/y % chg.) World Japan United States Euro Area Germany France Emerging Economies United Kingdom China Brazil India Russia Difference from April 2018 forecasts (% pts.) 3.6 0.8 2.9 1.9 1.4 1.7 1.4 6.6 1.1 6.8 2.3 3.2 0.9 2.6 1.3 0.7 1.3 1.3 6.2 0.8 7.0 1.2 3.5 0.4 1.9 1.6 1.7 1.4 1.4 6.0 2.4 7.2 1.9 -0.3 -0.4 0.0 -0.5 -1.1 -0.4 -0.2 0.0 -1.2 -0.6 0.6 -0.7 0.0 -0.1 -0.7 -1.3 -0.7 -0.2 -0.2 -1.7 -0.8 -0.3 -0.3 0.1 0.0 -0.1 0.2 -0.4 -0.1 -0.3 0.2 -0.7 0.4 Note: For India, figures are presented on a fiscal year basis. Source: IMF, “World Economic Outlook (July 2019, April 2018).” Chart 2 Global PMI DI, % pts. Global Manufacturing PMI Output Index Global Services PMI Business Activity Index CY 2012 13 19 19 Note: Figures are from the J.P. Morgan Global PMI. Figures above 50 indicate improvement and below 50 show deterioration on a month-on-month basis. Source: IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.) Chart 3 Global Production and Economic Policy Uncertainty y/y % chg. average from 1997 to 2015 = 100 Global Economic Policy Uncertainty Index (right scale) World industrial production (excl. constructions) Uncertainty intensifies -5 -10 -15 CY 05 Notes: 1. World industrial production is a weighted average of industrial production volume for each country. The latest figure is as of June 2019. 2. Global Economic Policy Uncertainty Index is a GDP-weighted average for 20 major countries including the United States, China, Japan, and European countries. The latest figure is as of July 2019. Sources: Economic Policy Uncertainty, "Global Economic Policy Uncertainty Index"; CPB Netherlands Bureau for Economic Policy Analysis, "Industrial Production Volume, CPB World Trade Monitor." Effects of the U.S.-China Trade Friction (Estimates by the IMF) Impact on Real GDP of the U.S. and China Chart 4 Impact on Global Real GDP Notes: 1. The left-hand graph indicates the marginal (i.e. additional) impact on the level of GDP from the announced and envisaged tariffs between the United States and China. The figures are the deviations from baseline projections in percentage terms. Announced tariffs correspond to an increase in tariffs from 10 percent to 25 percent on USD 200 billion of U.S. imports from China as of May 2019. Envisaged tariffs are the possible 25 percent tariff on the roughly USD 267 billion of U.S. imports from China. The simulations assume retaliation by China. 2. The right-hand graph shows the marginal effect on global GDP of the tariffs that were implemented in 2018 as well as the tariffs that were announced and envisaged in May 2019. The figures are the deviations from baseline projections in percentage terms. Source: IMF, "G20 Surveillance Note (June 8-9, 2019)." Chart 5 World Semiconductor Market Forecasts World Semiconductor Market Forecasts by Country/Region World Semiconductor Shipments Forecasts made in autumn 2018 1.4 U.S. Japan Europe Forecasts made in spring 2019 -23.6 Forecasts made in autumn 2018 1.9 Forecasts made in spring 2019 -3.1 Forecasts made in autumn 2018 2.5 Forecasts made in spring 2019 Asia -9.7 Forecasts made in autumn 2018 3.1 Forecasts made in spring 2019 CY 2018 y/y % chg. -10 -9.6 -30 CY 2019 CY 2020 y/y % chg. -20 CY Notes: 1. Figures are on a U.S. dollar denominated basis. 2. In the left-hand graph, figures for CY 2018 in the forecasts made in spring 2019 are actual figures. Others are forecasts. Source: WSTS Inc. Chart 6 Real GDP Growth and Breakdown by Component ann., q/q % chg. -5 Private consumption Private business fixed investment, etc. Government spending -10 Exports Imports -15 Change in inventories, etc. Real GDP -20 CY2013 CY Source: Cabinet Office, "Quarterly Estimates of GDP for April-June 2019 (First Preliminary Estimates)." 19 19 Chart 7 Outlook for Economic Activity and Prices (July 2019 Outlook Report) medians of Policy Board members' forecasts, y/y % chg. Real GDP CPI (all items less fresh food) Fiscal 2019 +0.7 +1.0 +0.8 Forecasts made in April 2019 +0.8 +1.1 +0.9 Fiscal 2020 +0.9 +1.3 +1.2 Forecasts made in April 2019 +0.9 +1.4 +1.3 Fiscal 2021 +1.1 +1.6 Forecasts made in April 2019 +1.2 +1.6 (Reference) Excluding the effects of the consumption tax hike and policies concerning the provision of free education Note: The direct effect of the consumption tax hike on the CPI for fiscal 2019 and fiscal 2020 is estimated to be 0.5 percentage point for each year. The direct effects of policies concerning the provision of free education on the CPI for fiscal 2019 and fiscal 2020 are estimated to be minus 0.3 percentage point and minus 0.4 percentage point, respectively. Source: Bank of Japan, "Outlook for Economic Activity and Prices (July 2019)." Chart 8 Real Exports Breakdown by Region y/y % chg. CY s.a., q/q % chg. Q3 Q4 Q1 Q2 s.a., m/m % chg. Q3 May June July United States 3.4 2.3 -0.2 4.1 0.3 4.7 -2.0 -5.3 2.8 -1.9 EU 4.6 6.1 -3.6 2.9 2.0 -3.4 6.7 -10.1 8.8 4.7 Asia 9.0 3.2 -0.1 -0.6 -3.2 0.5 -1.0 -6.3 7.4 -3.5 China 14.1 5.9 -0.4 -0.5 -5.4 1.6 -2.7 -0.4 2.4 -4.1 NIEs, ASEAN, etc. 6.4 1.8 0.1 -0.8 -1.9 -0.2 -0.3 -9.3 10.3 -3.4 Others 3.1 3.5 -6.9 2.7 -3.0 -2.5 14.2 8.1 -7.2 17.0 Real exports 6.4 2.2 -1.6 0.5 -1.7 0.1 2.1 -4.5 4.1 0.9 Breakdown by Goods y/y % chg. CY s.a., q/q % chg. s.a., m/m % chg. Q3 Q4 Q1 Q2 Q3 May June July Intermediate goods 1.4 2.5 0.4 3.0 -2.6 3.2 0.4 -6.5 9.2 -3.1 Motor vehicles and related goods 5.2 5.6 -2.9 1.9 0.2 -0.1 -1.1 -3.0 -2.3 1.5 IT-related goods 8.0 4.1 0.4 -1.1 -3.6 2.2 0.8 -5.1 5.0 -0.7 Capital goods 12.3 5.3 -2.3 -0.2 -3.6 -1.5 1.2 -9.1 4.1 1.7 Real exports 6.4 2.2 -1.6 0.5 -1.7 0.1 2.1 -4.5 4.1 0.9 Notes: 1. NIEs, ASEAN, etc. includes other Asian countries such as India and Bangladesh. 2. Motor vehicles and related goods includes motor vehicles, parts of motor vehicles, and power generating machine. IT-related goods includes computers and units, telecommunication machinery, semiconductors, audio and visual apparatus, and medical and optical instruments. Capital goods includes metalworking machinery, construction machines, electrical power machinery, semiconductor production equipment, and ships. 3. Figures for 2019/Q3 are those of July. Source: Bank of Japan, "Developments in Real Exports and Real Imports." Chart 9 Business Fixed Investment (Ratio to Nominal GDP) -10 -5 Ratio of nominal private non-resi. investment to nominal GDP (left scale) Production capacity DI (right scale) CY 2005 Note: Production capacity DI shows figures for large enterprises of all industries. Sources: Cabinet Office, "National Accounts"; Bank of Japan, "Tankan (Short-Term Economic Survey of Enterprises in Japan)." Excessive capacity Insufficient capacity diffusion index of "excessive capacity" minus "insufficient capacity," % pts., reversed % Developments in Business Fixed Investment Plans (Large Manufacturing Firms) y/y % chg. Overall Manufacturing y/y % chg. Chart 10 General-Purpose, Production, and Business Oriented Machinery Average (FY 2013-2018) FY 2018 FY 2019 Mar. survey June survey Sept. survey Dec. survey Forecast Actual Mar. survey Motor Vehicles y/y % chg. June survey Sept. survey Dec. survey Forecast Actual Forecast Actual Basic Materials y/y % chg. Mar. survey June survey Sept. survey Dec. survey Forecast Actual Note: Figures include software investment and exclude land purchasing expenses. Source: Bank of Japan, "Tankan." Mar. survey June survey Sept. survey Dec. survey Developments in Business Fixed Investment Plans (Large Nonmanufacturing Firms) y/y % chg. Overall Nonmanufacturing Construction y/y % chg. Average (FY 2013-2018) FY 2018 FY 2019 -10 Mar. survey Chart 11 y/y % chg. June survey Sept. survey Dec. survey Forecast Mar. survey Actual Wholesaling and Retailing -5 y/y % chg. June survey Sept. survey Dec. survey Forecast Actual Information Communication FY 2015 -10 Mar. survey June survey Sept. survey Dec. survey Forecast Actual -10 Note: Figures include software investment and exclude land purchasing expenses. Source: Bank of Japan, "Tankan." Mar. survey June survey Sept. survey Dec. survey Forecast Actual Chart 12 Household Consumption Employment-Related Indicators Real Consumption Jan. 2013 = 100 y/y % chg. s.a., DI Assessment of current economic conditions (level) Employment-related Durable goods Non-durable goods Active job openings (right scale) Services Overall (Consumption Activity Index, real) 113.2 50.2 105.2 -0.5 102.5 95.9 CY 2013 CY -3 Note: The latest figures are as of June 2019 for the real consumption and July 2019 for others. Sources: Bank of Japan, "Consumption Activity Index"; Cabinet Office, "Economy Watchers Survey"; Ministry of Health, Labour, and Welfare, "Employment Referrals for General Workers." Chart 13 Household Consumption Consumer Sentiment Consumption Before and After Tax Hikes Apr. 1996, Apr. 2013, Oct. 2018 = 100 s.a., DI s.a. Consumer Confidence Index Assessment of current economic condition level (household activity-related, right scale) Consumption tax hike Tax hike in Apr. 1997 (from 3% to 5%) Tax hike in Apr. 2014 (from 5% to 8%) Tax hike in Oct. 2019 (from 8% to 10%) -12 -10 -8 -6 -4 -2 +2 +4 +6 +8 +10 +12 CY months elapsed from consumption tax hike Note: Households with two or more persons are counted in Consumer Confidence Index (seasonal adjusted figures). Sources: Cabinet Office, "Synthetic Consumption Index," "Consumer Confidence Survey," "Economy Watchers Survey." Chart 14 Consumer Prices Measures of Underlying Inflation Consumer Price Index 2.0 y/y % chg. y/y % chg. % pts. 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 -1.0 -1.0 -1.5 Diffusion index (right scale) -2.0 CY 201112 12 13 13 14 14 15 15 16 16 17 17 18 18 Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications, "Consumer Price Index." Weighted median -1.5 CPI (all items less fresh food and energy) -25 Trimmed mean CPI (all items less fresh food) -2.0 -50 CY CY1 Note: The diffusion index is defined as the share of increasing items minus that of decreasing items. The share of increasing/decreasing items is the share of items in the CPI (less fresh food, consumption tax adjusted), for which the price increased/decreased from a year earlier. Sources: Bank of Japan, "Measures of Underlying Inflation"; Ministry of Internal Affairs and Communications. Chart 15 Output Gap and Inflation Expectations Output Gap %, % pts. 4.71% (1990/Q4) 1.70% (1997/Q1) 1.99% (2007/Q4) 1.98% (2018/Q4) 2.0 Synthetic Indicators of Inflation Expectations y/y % chg. Firms, households, and experts (Consensus Forecasts) Firms, households, and experts (QUICK Survey) Firms, households, and markets (inflation swap rate) 1.5 1.0 -2 -4 0.5 -6 Labor input gap Capital input gap Output gap -8 CY 1985 0.0 CY 10 Notes: 1. The data for the output gap in the left-hand graph are the estimates by the Bank's staff as of July 3, 2019. 2. In the right-hand graph, semiannual data from the Consensus Forecasts up through 2014/Q2 are linearly interpolated. Figures for the Bank’s Opinion Survey on the General Public’s Views and Behavior (Opinion Survey) exclude inflation expectations by respondents whose annual inflation expectations were ±5% or greater. 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. 3. In the right-hand graph, inflation expectations of firms are taken from the Tankan and those of households are taken from the Bank’s Opinion Survey. For experts’ and markets’ inflation expectations, data from the Consensus Forecasts, the QUICK Survey, and inflation swap rates are used as indicated by their respective lines. Sources: Consensus Economics Inc., “Consensus Forecasts”; QUICK Corp., "QUICK Monthly Market Survey (Bonds)"; Bloomberg; Bank of Japan. Outline of the Bank's Monetary Policy Chart 16 (1) Yield Curve Control Short-term rate: The Bank will apply minus 0.1 percent to the Policy-Rate Balances. Long-term rate: The Bank will purchase JGBs so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward or downward to some extent mainly depending on developments in economic activity and prices. (2) Asset Purchases The Bank will purchase ETFs and J-REITs so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively. With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions. (3) Commitment Overshooting commitment: The Bank 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. Forward guidance for policy rates: The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike. Chart 17 Unemployment Rate and Labor Force Participation Rate % % 64.2 62.0 Labor force participation rate (right scale) 2.2 Unemployment rate (left scale) CY1980 Oct. 92 95 Note: Seasonally adjusted figures. Source: Ministry of Internal Affairs and Communications, "Labour Force Survey." Chart 18 Factors that Contributed to the Change in the Labor Force Participation Rate % pts. Demographic factor Elderly (60 years old and above) Female (15-59 years old) Male (15-59 years old) Overall -2 -4 -6 -8 -10 CY 1992 Notes: 1. Given that the labor force participation rate is the population-weighted average of all age groups, the change in the labor force participation rate from October 1992 to July 2019 is decomposed into a demographic factor (the effect of changes in the demographic pyramid) and changes in the labor force participation rate of age groups. The labor force participation rate of each age group is calculated from the original series. 2. Figures are cumulative from October 1992. 3. Original series are linearly interpolated from March to August 2011 when data were not released. Source: Ministry of Internal Affairs and Communications, "Labour Force Survey." Labor Underutilization Indicator 4 (LU4) by Gender and Age Group Chart 19 (Average of the Apr.-June Quarter of 2019) % Potential labor force Female Persons not in labor force 65 years old and above 55-64 years old 45-54 years old 35-44 years old 25-34 years old 15-24 years old Total 65 years old and above 55-64 years old 45-54 years old 35-44 years old 25-34 years old 15-24 years old Total Male Labor underutilization Other Unemployed unemployed persons persons Unemployed persons Labor force Persons in time-related underemployment Potential labor force Persons in time-related underemployment Unemployed persons Employed persons Notes: 1. Ratios to the sum of labor force and potential labor force. 2. Labor Underutilization Indicator 4 (LU4) is the sum of unemployed persons, persons in time-related underemployment, and the potential labor force. Source: Ministry of Internal Affairs and Communications, "Labour Force Survey (Detailed Tabulation)."
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bank of japan
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 24 September 2019.
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September 24, 2019 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka 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 a distinguished gathering of business leaders in the Kansai region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the various activities of the Bank of Japan's branches in Osaka, Kobe, and Kyoto. At the Monetary Policy Meeting (MPM) held last week, the Bank, regarding the price developments in Japan, judged that it was becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target of 2 percent will be lost. The Bank also made clear in its policy statement that, while taking this situation into account, it will reexamine economic and price developments at the next MPM, when it compiles the Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to talk about the Bank's view regarding the economic and price developments on which its judgment was based and then explain the basic thinking behind the conduct of monetary policy. I. Economic Developments at Home and Abroad Let me start by talking about developments in overseas economies. Overseas economies have been growing moderately on the whole, but the pace has continued to decelerate since the start of the year (Chart 1). According to the World Economic Outlook (WEO) Update released by the International Monetary Fund (IMF) in July, growth is forecast at 3.2 percent in 2019 on a year-on-year basis, marking a decline from the previous year's figure of 3.6 percent. Growth in the world trade volume has been decelerating clearly, mainly against the background of the increasing and prolonged U.S.-China trade friction and adjustments in IT-related goods. The diffusion indexes (DIs) for business sentiment of manufacturing firms on a global basis have remained below 50 since May, which is the borderline between improvement and deterioration of business conditions perceived by firms. Looking at developments in major regions, the U.S. economy has continued to expand moderately, supported primarily by an increase in private consumption. On the other hand, the Chinese and European economies have continued to be somewhat weak. Specifically, the manufacturing sector in China has remained weak, mainly due to the effects of additional tariffs imposed by the United States and the authorities' measures to push forward with deleveraging. As for Europe, production has declined since the second half of last year, mainly in Germany, partly reflecting the tightening of gas emission regulations on automobiles within the European Union (EU), and weaker exports to China also have been exerting downward pressure on the European economy. Looking at Japan's economy, exports -- mainly those of capital goods related to business fixed investment to China as well as the NIEs and the ASEAN economies -- have been relatively weak since the turn of the year, affected by the slowdown in overseas economies (Chart 2). In addition, weakness in exports and related production is leading manufacturing firms to have cautious sentiment. On this point, since the Kansai region, in particular, has a strong economic relationship with the Asian economies, such as China, you may feel such developments. That said, domestic demand has remained firm. Thus far, the effects of the slowdown in overseas economies do not seem to be exerting on domestic demand (Chart 3). Business fixed investment has continued on an increasing trend, with corporate profits staying at high levels on the whole. According to the Financial Statements Statistics of Corporations by Industry, Quarterly (FSSC), the ratio of current profits to sales for all industries and enterprises has remained at a historically high level. In this situation, business fixed investment on a GDP basis has maintained its uptrend, being positive for the April-June quarter on a quarter-on-quarter basis. Turning to the household sector, private consumption has increased moderately, albeit with fluctuations. This is mainly attributable to the continued improvement in the employment and income situation (Chart 4). The active job openings-to-applicants ratio has been at a high level that exceeds the peak marked during the bubble period, and the unemployment rate has been in the range of 2.0-2.5 percent, remaining at around a low level that was observed during the bubble period. While labor market conditions have remained tight, employee income has been increasing. Japan's economy thus has been on a moderate expanding trend, with a virtuous cycle from income to spending continuing to operate in both the corporate and household sectors, although exports have shown some weakness. With regard to the outlook, Japan's economy is likely to continue on a moderate expanding trend, despite being affected by the slowdown in overseas economies for the time being. The keys to this outlook are the following: (1) the timing of a pick-up in overseas economies and (2) whether the firmness in domestic demand will be sustained until that happens. I now would like to talk about the sustainability of domestic demand. Private consumption is expected to continue increasing moderately as the employment and income situation continues to improve. Although the impact of the scheduled consumption tax hike warrants attention, it is likely to be marginal compared to that of the previous tax hike in 2014, mainly because an increase in household burden will be smaller and various measures to smooth out demand prior to and after the tax hike will be implemented. In addition, government spending is expected to underpin the economic activity going forward, mainly on the back of an increase in public investment accompanied by policy measures for national resilience and of spending on hosting the Olympic and Paralympic Games. The sustainability of domestic demand depends on business fixed investment. Business fixed investment has been steady despite the slowdown in overseas economies, and this likely is attributable to an increase in investment that is relatively less susceptible to changes in overseas demand and the business cycle, including that aimed at improving efficiency and saving labor in order to deal with labor shortage, that in research and development (R&D) for growth areas, and that related to urban redevelopment projects. In fact, in the Kansai region, an increase is seen in a wide range of medium- to long-term strategic investment, such as R&D investment in life science, which is the theme of the World Expo to be held in Osaka, Kansai, and investment related to the digitalization of automobiles and use of 5G network. Also, the redevelopment projects in Osaka are getting underway in such areas as Kita (or "the North") and Minami (or "the South"). With regard to the outlook, business fixed investment is expected to increase moderately on the back of high levels of corporate profits and highly stimulative financial conditions. Thus, it can be said that the sustainability of domestic demand in Japan is substantially high. However, business and household sentiment could be affected, depending on developments in overseas economies and financial markets. In particular, if the slowdown in overseas economies lasts longer than expected, it is necessary to pay attention to the possibility that firms' investment stance will become cautious, mainly in the manufacturing sector. Next, I would like to explain the other key point, which is the outlook for overseas economies. Although it is likely that slowdowns will continue to be observed for the time being, the growth rates are projected to rise somewhat thereafter, partly backed by the materialization of the effects of fiscal and monetary policies in each economy and the progress in global adjustments in IT-related goods. Thus, overseas economies are expected to grow moderately on the whole. As for now, overseas economies are projected to pick up in the second half of 2019 and into 2020, which is in line with the projections made by such as the IMF. On this point, adjustments in IT-related goods seem to be moving out of the phase of continued deterioration, but there is no clear sign that the global economy will turn to a pick-up. Under these circumstances, downside risks concerning overseas economies seem to be increasing (Chart 5). Since both the United States and China have been increasing incrementally the number of goods subject to additional tariffs, the trade friction between these economies appears to be increasing and becoming more prolonged. They are exhibiting a stance of continuing with the negotiations, but future developments continue to warrant attention. In addition to the trade friction, uncertainties concerning overseas economies include various factors such as the consequences of the negotiations on the United Kingdom's exit from the EU, the effects of stimulus measures in China, and geopolitical risks in the Middle East. Uncertainties surrounding developments in emerging economies also are of concern. Thus, in a situation where downside risks concerning overseas economies seem to be increasing, it is necessary to bear in mind the possibility that the pick-up will lag behind by longer than expected. The Bank judges that it is becoming necessary to closely examine whether overseas economies will pick up while the aforementioned firmness in domestic demand is being maintained. II. Price Developments in Japan Let me move on to price developments. The year-on-year rate of change in the consumer price index (CPI) has been at around 0.5 percent (Chart 6). It has been relatively weak compared to the economic expansion and tight labor market conditions. While there are various reasons for this, it seems to be affected largely by the fact that the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched in Japan, due to the experience of prolonged low growth and deflation. Thus, it is taking time for firms' cautious wage- and price-setting stance, as well as households' cautiousness toward price rises, to change. However, the basic mechanism has continued to operate in which a positive output gap -- a rise in the level of economic activity -- results in moderate increases in wages and prices. Let me elaborate on this point. As I mentioned earlier, in a situation where the economy has been expanding moderately and labor market conditions have remained tight, wages of employees have continued to rise and base pay increases have been achieved for a sixth consecutive year. On the other hand, firms have faced upward pressure such as of personnel expenses and distribution costs on prices resulting from an increase in economic activity. In this situation, moves to raise selling prices have been spreading gradually among firms (Chart 7). Regarding the output prices DI in the Tankan (Short-Term Economic Survey of Enterprises in Japan), the situation has continued for seven consecutive quarters in which the proportion of enterprises answering that the output prices have risen has exceeded the proportion of those answering that such prices have fallen. This already has lasted for a longer period than that observed during the bubble period. Firms' stance steadily has shifted toward further raising prices. In addition, looking at annual price changes across all CPI items, the share of price-increasing items minus the share of price-decreasing items recently has been increasing moderately. Of course, the reason why firms can raise selling prices is that households' tolerance of price rises has been increasing, albeit moderately, on the back of improvement in the employment and income situation. Such improvement has been achieved especially because the economy has been expanding moderately and the positive output gap has been maintained. As for the outlook, it is likely that Japan's economy will continue on an expanding trend and the output gap will remain positive. With the level of economic activity remaining high, firms' stance is expected to gradually shift toward further raising wages and prices and medium- to long-term inflation expectations of firms and households, which have been more or less unchanged recently, are projected to rise gradually. Under these circumstances, the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent, although this will take time. Regarding this baseline scenario of the outlook for prices, however, risks are skewed to the downside. In particular, recently, slowdowns in overseas economies have continued to be observed and their downside risks seem to be increasing. Thus, it is necessary to pay closer attention to the risk that the economic slowdown stemming from overseas economies will spread to prices. I will elaborate on this point later when I talk about the Bank's thinking behind the conduct of monetary policy. III. The Bank's Conduct of Monetary Policy Now, I would like to talk about the Bank's conduct of monetary policy. The Bank has been pursuing powerful monetary easing under the framework of "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control," aiming to achieve the price stability target of 2 percent (Chart 8). The main transmission mechanism of monetary easing that the Bank assumes is to lower real interest rates, which are calculated by subtracting inflation expectations from nominal interest rates. Real interest rates currently are well below the natural rate of interest, which is neutral to economic conditions, and are stimulating a wide range of economic activities. In this situation, the inflation mechanism driven by the positive output gap has been operating, as I mentioned earlier. In order to achieve the price stability target, the Bank considers it important to ensure that the inflation mechanism continues to operate and thereby maintain the momentum toward achieving the target. This stance of monetary policy conduct by the Bank basically has not changed from a year ago, when I spoke at this meeting last time. On the other hand, monetary policy conduct of major central banks abroad has changed significantly from last year's moves toward normalization. This month, the European Central Bank (ECB) decided to lower one of its policy rates and restart its asset purchases, and the Federal Reserve also decided to lower its policy rate, following the rate cut in July. Factors that lie behind these decisions are the prolonged slowdown in the global economy and heightening uncertainties, which Japan is also facing. At the press conference after the decision to take monetary easing measures, President Draghi of the ECB underlined that, in an environment of prolonged uncertainties related to, for example, geopolitical factors and the rising threat of protectionism, international trade had been weakening and downside risks surrounding the euro area economy were significant. The Bank of Japan has the same policy stance, in that preventing and insuring against risks are taken into consideration when conducting monetary policy. In doing so, what is essential for the Bank is assessment of the momentum toward achieving the price stability target of 2 percent. If there is a greater possibility that such momentum will be lost, the Bank will not hesitate to take additional easing measures. While various factors are considered when examining the momentum toward achieving the price stability target, the following two points are particularly important. First is whether the positive output gap, or the high level of economic activity, will be maintained, and whether firms' stance will shift toward further raising wages and prices under such situation. Second is developments in medium- to long-term inflation expectations of firms and households. Based on these points, the Bank deems that the momentum toward achieving the price stability target has been maintained so far. With the output gap remaining positive, moves to raise selling prices reflecting cost increases have been observed recently in a wide range of firms. As for the outlook, inflation expectations are projected to rise as many of the factors that have been delaying inflation will be resolved gradually and moves to raise prices will spread widely. Under these circumstances, the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent. Thus, the Bank judges it appropriate to continue with the current monetary policy. However, given that slowdowns in overseas economies have continued to be observed and their downside risks seem to be increasing, it is becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target will be lost. Developments in the output gap warrant particular attention. If downside risks to overseas economies materialize, there is a possibility that the growth rate of Japan's economy will decelerate substantially through, for example, the prolonged weak exports and firms' investment stance becoming cautious. If this happens, the momentum toward achieving the price stability target could be affected through shrinkage of the output gap. Attention also should be paid to the fact that the impact of the so-called adaptive formation mechanism is large in Japan, in which the actual inflation rate affects inflation expectations. Although crude oil prices temporarily rose somewhat due to increased geopolitical risks, they have declined to some extent from a somewhat longer-term perspective, mainly against the background of the slowdown in overseas economies. If crude oil prices decline further and the actual inflation rate decreases clearly, inflation expectations also may be affected. Considering that it is becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target will be lost, the Bank will thoroughly reexamine economic and price developments at the next MPM, when it releases the Outlook Report. It will examine economic and price developments from a broad perspective at the next MPM, based on observations that will be available by the time of the meeting, such as various economic indicators, the reports at the meeting of general managers of the Bank's branches, and developments in financial markets. Recently, the situation has been changing rapidly, with investors' risk aversion abating somewhat due to expectations for progress in U.S.-China trade negotiations. Let me also add that the Bank does not have any preconception at this point regarding the outcome of its examination. Before closing my speech, I would like to elaborate on the Bank's basic thinking on the current conduct of monetary policy. There are three points. First, the Bank's conduct of monetary policy will continue to be based on the current framework of "QQE with Yield Curve Control," which is highly sustainable and enables the Bank to make flexible adjustments according to developments in economic activity and prices as well as financial conditions. Possible measures for monetary easing include cutting the short-term policy interest rate, lowering the target level of 10-year Japanese government bond (JGB) yields, expanding asset purchases, and accelerating the expansion of the monetary base. Combinations or applications of these various measures would also be an option. The Bank will take appropriate measures depending on the situation, but in any event, the policy effects will be exerted basically through real interest rates and risk premia of asset prices. Second, the Bank considers that the conclusion reached in the Comprehensive Assessment released in September 2016, in which it assessed the policy effects and their transmission mechanism since the introduction of QQE, is still valid even in the present situation. For example, there is no change in our recognition regarding the impact on economic activity and prices of the term structure of interest rates, in that short- and medium-term interest rates have a larger impact than longer-term rates. On the other hand, the Bank continues to take the view that an excessive decline in super-long-term interest rates could lower the rates of return such as on insurance and pension products, and this may exert a negative impact on economic activity through a deterioration in people's sentiment. And third, it is important to consider appropriate monetary policy measures while thoroughly weighing their benefits and costs. As I mentioned earlier, "QQE with Yield Curve Control" has been exerting its effects firmly by stimulating a broad range of economic activities through the decline in real interest rates. That said, if the low interest rate environment is prolonged further, it will become necessary to pay closer attention to the costs of policy measures, including the impact on the functioning of financial intermediation and market functioning. Thus, the Bank recognizes that there remains an important challenge to consider what is required to further enhance the sustainability of policy measures. The Bank will continue to pursue policy conduct in an appropriate manner without preconception, taking account of developments in economic activity and prices as well as financial conditions, while carefully examining various risks. It also will continue to make its utmost efforts as a central bank and strongly support firms' activity in Japan. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Osaka September 24, 2019 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Economic Developments at Home and Abroad II. Price Developments in Japan III. The Bank's Conduct of Monetary Policy Chart 1 I. Economic Developments Global Economy Global Growth Rate (IMF Projections) 6.0 y/y % chg. World Trade Volume y/y % chg. 5.5 5.0 2020: +3.5% 4.5 2018: +3.6% 4.0 3.5 -1 CY 12 3.0 Global Manufacturing PMI 2.5 2019: +3.2% Average from 1980 through 2018: +3.5% 2.0 Global economy Advanced economies Emerging and commodity-exporting economies 59 s.a., DI. Projections 1.5 1.0 0.5 0.0 -0.5 CY 00 CY 12 Notes: 1. In the left chart, figures for 2019 and 2020 are IMF's projections as of July 2019. Notes: 2. In the upper right chart, figures are those for real imports. Notes: 3. In the lower right chart, figures for the global economy are the "J.P. Morgan Global Manufacturing PMI." Figures for advanced economies as well as emerging and commodityexporting economies are calculated as the weighted averages of the Manufacturing PMI using GDP shares of 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, such as China, South Korea, Taiwan, Russia, and Brazil. Sources: CPB Netherlands Bureau for Economic Policy Analysis; IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.); IMF, etc. Chart 2 I. Economic Developments Exports, Production, and Business Sentiment Exports and Production Business Conditions DI (Tankan) s.a., 2012/Q1=100 Real Exports Manufacturing Nonmanufacturing Production DI ("favorable" - "unfavorable"), % points -5 -10 -15 CY 12 Sources: Ministry of Finance; Ministry of Economy, Trade and Industry; Bank of Japan. -20 CY 12 Chart 3 I. Economic Developments Domestic Demand Business Fixed Investment and Corporate Profits s.a., ann., tril. yen Private Consumption s.a., % s.a., CY 2011=100 Private nonresidential investment (SNA, real, left scale) Consumption Activity Index (travel balance adjusted, real) Ratio of current profits to sales (right scale) CY09 CY09 Notes: 1. In the left chart, figures for the ratio of current profits to sales are based on the "Financial Statements Statistics of Corporations by Industry, Quarterly." Excluding "finance and insurance." Figures from 2009/Q2 exclude "pure holding companies." Notes: 2. In the right chart, figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption. Sources: Ministry of Finance; Cabinet Office; Bank of Japan, etc. Chart 4 I. Economic Developments Employment and Income Situation Labor Market Conditions s.a., % Employee Income s.a., ratio 1.8 y/y % chg. Unemployment rate (left scale) 1.6 Active job openings-toapplicants ratio (right scale) 1.4 1.2 -2 1.0 Total cash earnings -4 Number of employees 0.8 0.6 CY 04 0.4 Employee income -6 -8 Note: In the right chart, figures for the employee income, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Employee income = total cash earnings ("Monthly Labour Survey") × number of employees ("Labour Force Survey"). Figures for the "Monthly Labour Survey" from 2013/Q1 are based on corrected figures adjusted for establishments in Tokyo with 500 or more employees. Figures from 2016/Q1 are based on continuing observations following the sample revisions of the "Monthly Labour Survey." Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 5 I. Economic Developments U.S.-China Trade Friction U.S. Average Tariffs on Chinese Goods China's Average Tariffs on U.S. Goods % 4th round 4th round (September) Rise in tariffs imposed in the 3rd round Rise in tariffs imposed in the 3rd round 1st-3rd rounds 1st-3rd rounds % Base tariff rate Other Base tariff rate Start of End of May Start of Sep. 2018 average June Sep. Note: Average tariffs are BOJ staff estimates based on such factors as the tariff rates under most-favored-nation treatment at the start of 2018, additional tariffs by goods, and the trade value between the U.S. and China in 2017. Sources: Census Bureau; U.S. government; WTO; UN Comtrade; Chinese government; Bown, Chad P. 2019. US-China Trade War: The Guns of August. PIIE Trade and Investment Policy Watch blog, Peterson Institute for International Economics (August 26). Chart 6 II. Price Developments Consumer Prices and Output Gap Consumer Prices Output Gap 6 % y/y % chg. CPI (all items less fresh food) Excess demand CPI (all items less fresh food and energy) -2 -1 -4 -2 -6 -3 CY 85 Notes: 1. In the left chart, figures are adjusted for changes in the consumption tax rate. Notes: 2. In the right chart, figures are based on BOJ staff estimations. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. -8 CY 85 Excess supply Chart 7 II. Price Developments Situation Surrounding Consumer Prices Changes in Output Prices (Tankan) Diffusion Index of Price Changes 10 DI ("rise" - "fall"), % points -5 -10 -15 -20 -10 -25 -20 -30 -30 -35 -40 -40 CY 05 % points -50 CY 05 More price-increasing items More price-decreasing items Note: In the right chart, the diffusion index is defined as the share of price-increasing items minus the share of price-decreasing items. The share of price-increasing/decreasing items is the share of items in the CPI (less fresh food, consumption tax adjusted) for which price indices increased/decreased from a year earlier. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 8 III. The Bank's Conduct of Monetary Policy Yield Curve Control % 1.2 Recent 1.0 Average Bottom 0.8 Target level of the long-term interest rate: around zero percent Peak 0.6 0.4 Short-term policy interest rate: minus 0.1 percent 0.2 0.0 -0.2 -0.4 -0.6 residual maturity, year Note: Figures for average, bottom, and peak are of JGB yields since the introduction of yield curve control (Sep. 21, 2016). Those for bottom and peak are of 10-year JGB yields. Source: Bloomberg.
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Speech by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Mie, 25 September 2019.
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September 25, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Mie Takako Masai Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices I would like to start my speech with a look at developments in economic activity and prices. Following the discussion at the Monetary Policy Meeting (MPM) held on July 29 and 30, 2019, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices through fiscal 2021. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas Economies Let me first touch on developments in overseas economies. The Bank assesses that, although overseas economies have been growing moderately on the whole, slowdowns have continued to be observed. Private consumption has been firm on the whole, mainly due to the favorable employment and income situation. However, the effects of trade friction are becoming evident in the form of deceleration in the pace of increase in the world trade volume, and it is confirmed that this, together with adjustments in the cycle for IT-related goods, has led to a deterioration in business sentiment and a decline in the propensity toward investment, particularly in the manufacturing sector. Indeed, the Global Purchasing Managers' Index (PMI) for manufacturing has been below the 50 mark and continued to decline since May 2019 -- that is, four consecutive months -- while the U.S. ISM Manufacturing Index also fell below 50 in August for the first time since August 2016 -- that is, about three years. My view is that other central banks and international organizations have been sharing concerns about this situation. For instance, the G20 Osaka Leaders' Declaration adopted in June 2019 states that "[global economic] growth remains low and risks remain tilted to the downside." According to the World Economic Outlook (WEO) Update released in July 2019 by the International Monetary Fund (IMF), the growth rate of the global economy is projected to decelerate to 3.2 percent in 2019 but pick up to 3.5 percent -- about the same level as the past average -- in 2020; however, these projections were revised downward from the previous ones made in the April 2019 WEO, marking the fourth consecutive downward revision. Moreover, it was indicated by the IMF itself that the projections are "precarious" and presume that progress will be made toward resolving trade policy differences. Looking at developments by major region, the U.S. economy has continued to be underpinned by the household sector against the backdrop of solid growth in employment and income. Although economic growth in some countries -- such as France -- is being underpinned by consumption, the European economy as a whole, in contrast, has seen moves to defer investment, partly against the backdrop of uncertainty over political developments, and there are no signs of the business sentiment of manufacturing firms -especially those in Germany -- bottoming out. With regard to Germany in particular, the Deutsche Bundesbank assessed that the growth rate of the economy for the July-September quarter of 2019 could be negative for the second consecutive quarter, following the April-June quarter. The Chinese economy has continued to see stable growth on the whole, but weakness has been observed in manufacturing, as suggested by such indicators as industrial output -- for which growth for July was at its lowest level in about ten and a half years and decelerated further in August. In other emerging and commodity-exporting economies, such as the NIEs and ASEAN economies, effects of adjustments in IT-related goods, for example, have been observed. In terms of the outlook for overseas economies, slowdowns are likely to continue for the time being; thereafter, however, such economies are expected to grow moderately on the whole, with the growth rates rising somewhat, partly due to the effects of each economy's stimulus measures and a pick-up in manufacturing, where relatively weak developments have been observed mainly in IT-related and capital goods. Nevertheless, there are concerns that, with the Brexit deadline approaching, global financial market conditions might suddenly change depending on the outcome of negotiations on the United Kingdom's exit from the European Union (EU), and I am of the view that downside risks to business activity remain significant, mainly for manufacturing, with trade issues becoming chronic, particularly between the United States and China. Accordingly, I am paying particular attention to the timing and the pace of the pick-up in overseas economies. B. Japan's Economy 1. Current situation Now I would like to move on to developments in Japan's economy. The Bank assesses that Japan's economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports, production, and business sentiment have been affected by the slowdown in overseas economies. The assessment of the underlying trend as a whole is unchanged from the previous Outlook Report released in April 2019, but the slowdown in overseas economies seems to be affecting not only exports and production, as has been seen to date, but also the business sentiment of some firms as well as manufacturers' machinery investment, among others. In the meantime, domestic demand, such as business fixed investment, has maintained its firmness, mainly in nonmanufacturing, and private consumption has been increasing moderately, albeit with fluctuations; thus, the output gap has remained positive and the real GDP growth rate for the April-June quarter of 2019, which was released in August, was 1.3 percent on an annualized quarter-on-quarter basis, registering a positive figure for the third consecutive quarter. Looking at developments by major expenditure item, with corporate profits staying at relatively high levels on the whole, the uptrend in business fixed investment has been maintained, mainly in investment intended for domestic capacity expansion, that aiming at saving labor in order to deal with labor shortage, and that in research and development for growth areas. Especially in nonmanufacturing, an increase has been observed in construction of logistics facilities, reflecting the expansion of e-commerce business, and of accommodation facilities to meet the demand of inbound visitors. Meanwhile, according to the Financial Statements Statistics of Corporations by Industry, Quarterly, business fixed investment by manufacturing firms for the April-June quarter of 2019 was minus 6.9 percent on a year-on-year basis, falling below the previous year's level for the first time in two years, due mainly to the effects of trade issues. Private consumption has maintained its moderate increasing trend with labor market conditions remaining tight and the income situation continuing to improve, albeit with fluctuations resulting from weather conditions. Exports have continued to show some weakness, mainly reflecting the effects of the slowdown in overseas economies. As a result of this situation, production mainly of export-related goods has exhibited some weak developments, but industrial production as a whole has been more or less flat. In these circumstances, business sentiment has been weakening somewhat, mainly in manufacturing. 2. Baseline scenario of the outlook for economic activity Japan's economy is likely to continue on an expanding trend throughout the projection period, which covers from fiscal 2019 through fiscal 2021. In fiscal 2019, exports are projected to continue showing some weakness for the time being, reflecting the slowdown in overseas economies, and business fixed investment also is likely to decelerate somewhat, mainly for manufacturing. Thereafter, exports are projected to return to their moderate increasing trend, with the growth rates of overseas economies rising gradually. The rate of increase in business fixed investment is expected to rise somewhat due to increases, for example, in labor-saving investment. Private consumption is likely to be pushed down for some time due to the effects of the scheduled consumption tax hike, but is expected to continue increasing as the employment and income situation continues to improve. Public investment also is likely to increase, reflecting Olympic Games-related demand and expansion in expenditure such as for national resilience. In fiscal 2020, the pace of increase in exports is expected to accelerate, with the growth rates of overseas economies rising, and government spending accompanying the hosting of the Olympic Games is expected to underpin the economy. Business fixed investment is likely to maintain a moderate uptrend. Private consumption and housing investment are expected to head gradually toward a recovery from a decline after the scheduled consumption tax hike. In fiscal 2021, private consumption and housing investment are projected to increase because the effects of the reactionary decline to the scheduled consumption tax hike are likely to dissipate, although Olympic Games-related expenditure -- which had been increasing -- will have been completed. Exports and business fixed investment are likely to maintain their moderate uptrend. In terms of the medians of the Policy Board members' forecasts in the July Outlook Report, the real GDP growth rate is 0.7 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.1 percent for fiscal 2021. 3. Uncertainties regarding the baseline scenario for economic activity There are various uncertainties regarding the baseline scenario of the outlook for Japan's economic activity, and I would like to explain two points to which I currently pay particular attention. First is the risk that the timing of the bottoming out of external demand will delay. Since the latter half of 2018, I have assessed that risks are tilted to the downside, particularly those regarding developments in overseas economies. Recently, due to political factors such as the strengthening of protectionist moves, downside risks seem to be increasing further. I am concerned that this could affect the timing of the bottoming out of external demand through various channels including disruptions in financial markets and a reduction in firms' incentive to invest caused by developments in trade. Second is the effects of the consumption tax hike scheduled to take place in October 2019. The planned increase in the tax rate is smaller than that at the time of the previous hike in April 2014, and the government plans to implement measures such as a reduced tax rate, a point reward program when using cashless payments, and more flexibly passing on the rise in the consumption tax to sales prices. Taking these into consideration, the baseline scenario is that the negative impact of the tax hike on the growth rates will be smaller than that of the previous hike. Nevertheless, I am paying attention to future consumption, together with possible further heightening in the current geopolitical risks. I would like to carefully examine the situation, including these two points, in the upcoming October Outlook Report. C. Price Developments 1. Current situation Next, I will turn to price developments in Japan. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food is currently at around 0.5 percent; it seems to have hit a lull somewhat in the uptrend, as the effects of energy price drops have started to appear. Nevertheless, the general public's gut feeling seems to be that prices are rising gradually. I believe that this is affected by the rise in prices of food products, which are staple purchases. Actually, the year-on-year rate of change in the CPI saw an acceleration in its growth for an increasing number of food products since early spring; in addition, the Unit Value Price Index released by Hitotsubashi University (SRI-Hitotsubashi Consumer Purchase Index) and the Nikkei CPINow-T Index, both of which are calculated based on point-of-sales (POS) data collected at supermarkets, for example, maintained their high growth. As described in the Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE), which was released by the Bank in September 2016, the adaptive component plays a considerably larger role in Japan than in other countries in the formation of inflation expectations, which means that inflation expectations tend to be influenced by past inflation rates. A similar trend has been confirmed by subsequent studies. 1 In other words, it is important to make cumulative efforts to raise inflation rates; as Gertler pointed out, for an economy that barely has a history of inflation being anchored at a targeted rate, "they [individuals] have to see it to believe it."2 From this viewpoint, my understanding of See, for example, Toshitaka Maruyama and Kenji Suganuma, "Inflation Expectations Curve in Japan," Bank of Japan Working Paper Series, no.19-E-6, April 2019, http://www.boj.or.jp/en/research/wps_rev/wps_2019/data/wp19e06.pdf. 2 Mark Gertler, "Rethinking the Power of Forward Guidance: Lessons from Japan," IMES Discussion Paper Series, No. 2017-E-8, Bank of Japan, Institute for Monetary and Economic Studies (IMES), October 2017, https://www.imes.boj.or.jp/research/papers/english/17-E-08.pdf. the several signs of changes that recently have started to appear is that they are arising in a situation where we gradually are taking positive steps. In fact, in contrast to the year-on-year rate of increase in the CPI for all items less fresh food that I mentioned earlier, that for all items less fresh food and energy has remained flat at a level around 0.5 percent since the beginning of this fiscal year. In addition, signs of changes -- albeit slight -- seem to have appeared in view of the fact that price rises by firms are beginning to spread to a broader range of products, and given other data, such as the trimmed-mean CPI, which excludes extreme relative price changes. Turning to inflation expectations, the expected inflation rate for the next five years surpassed 1 percent for the first time since 2013, according to an estimation by the Bank's staff based on the results of the Opinion Survey on the General Public's Views and Behavior. The fact that the adaptive component is playing a considerably large role can be explained by people's mindset and behavior based on the assumption that wages and prices will not increase easily having been deeply entrenched. I assume that households are gaining cumulative experiences through rises in base pay for six consecutive years and in the year-on-year rate of increase in employee income on a quarterly basis for 26 quarters in a row, although the rates of increase are modest. As a matter of fact, households' tolerance of price rises, which the Bank's staff calculated, seems to have been on an improving trend, and I am of the view that these also are signs of positive changes. As I have explained so far, I have the sense that, although we still have some distance to go to achieve the price stability target of 2 percent, there are some signs that the momentum toward achieving the target could strengthen again. In other words, I feel that we are approaching an important phase where firms' and households' tolerance of price rises could Based on empirical analysis, the following paper concludes that individuals' expectations of future inflation rates are influenced by the inflation rates that they actually have experienced. Jess Diamond, Kota Watanabe, and Tsutomu Watanabe, "The Formation of Consumer Inflation Expectations: New Evidence From Japan's Deflation Experience," Bank of Japan Working Paper Series, no.19-E-13, August 2019, http://www.boj.or.jp/en/research/wps_rev/wps_2019/data/ wp19e13.pdf. improve, and expected inflation rates could rise further. Therefore, I believe that it is extremely important to encourage this development. 2. Baseline scenario of the outlook for prices With regard to the outlook for prices, the year-on-year rate of change in the CPI for all items less fresh food is likely to increase gradually toward 2 percent, mainly on the back of the output gap remaining positive and medium- to long-term inflation expectations rising. The medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI for all items less fresh food presented in the July Outlook Report was 1.0 percent for fiscal 2019, 1.3 percent for fiscal 2020, and 1.6 percent for fiscal 2021. 3. Risks to prices Specific risk factors to prices are developments in firms' and households' medium- to long-term inflation expectations, the fact that the responsiveness of prices of some items to the output gap is low, and developments in foreign exchange rates and international commodity prices going forward. My recent concern is that, amid significant downside risks concerning overseas economies, negative effects would be exerted on prices through the third risk factor in the case of disruptions in global financial markets. II. The Bank's Monetary Policy Next, I will talk about the Bank's monetary policy. A. Current Monetary Policy Framework The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and is conducting monetary policy to achieve this target at the earliest possible time. Specifically, under the framework of QQE with Yield Curve Control, it has supported the economic activity of firms and households by maintaining highly accommodative financial conditions. This framework mainly consists of four components: yield curve control, purchases of risky assets, an inflation-overshooting commitment, and forward guidance for policy rates. The first component, yield curve control, is a policy under which the Bank aims to keep short- and long-term interest rates stable at low levels. Namely, 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 10-year Japanese government bond (JGB) yields at around 0 percent, and conducts JGB purchases so as to achieve this target level. The second component is purchases of risky assets; with a view to lowering risk premia of asset prices, the Bank purchases exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively. The third component, the inflation-overshooting commitment, is a policy under which the Bank commits itself to continuing to expand the monetary base -- the total amount of money the Bank directly supplies to the economy -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 fourth component, forward guidance for policy rates, presents the Bank's stance of maintaining the current extremely low levels of shortand long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike. B. Persistently Continuing with Powerful Monetary Easing The Bank introduced QQE in April 2013 and has continued with powerful monetary easing. However, as it gradually became clear that it likely would still take time to achieve the price stability target of 2 percent, it decided to strengthen the framework for QQE with Yield Curve Control in July 2018. Specifically, it decided to enhance the sustainability of powerful monetary easing by (1) strengthening its commitment to achieving the price stability target by introducing forward guidance for policy rates and (2) conducting market operations and asset purchases in a more flexible manner. To elaborate on the second point, the Bank announced that, in purchasing JGBs, the yields might move upward and downward to some extent, mainly depending on developments in economic activity and prices. It also decided to conduct such purchases in a flexible manner so that their amount outstanding would increase at an annual pace of about 80 trillion yen. Furthermore, it decided to purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively. At the same time, with a view to lowering risk premia of asset prices in an appropriate manner, the Bank announced that it might increase or decrease the amount of purchases depending on market conditions. By allowing for some elasticity in the monetary policy framework, the Bank can respond flexibly to some extent to developments in financial markets. Moreover, in April 2019, the Bank made clearer its policy stance to persistently continue with powerful monetary easing. Specifically, regarding its forward guidance for policy rates, the Bank added developments in overseas economies as a factor to consider when judging whether it would maintain the current extremely low levels of short- and long-term interest rates; in addition, it clearly presented a point of reference for the expression "for an extended period of time" as at least through around spring 2020. Furthermore, in order to contribute to smooth implementation of fund-provisioning and asset purchases as well as secure market functioning, the Bank decided to take the following measures and initiative: (1) expand eligible collateral for the Bank's provision of credit; (2) improve the use of the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth; (3) relax the terms and conditions for the Securities Lending Facility (SLF); and (4) consider introducing an ETF lending facility. The Bank will persistently continue with powerful monetary easing in a sustainable manner under the framework of QQE with Yield Curve Control by devising measures considered necessary at the time and strengthening the framework. C. Coping with Current Uncertainties My understanding is that global financial markets as a whole remain risk averse, and this development seems to be strengthening recently amid rapid alternation between pessimism and optimism due to factors of a very strong political nature. For example, in Germany, interest rates on all instruments from overnight loans to 30-year government bonds temporarily became negative, and in Switzerland, interest rates on all instruments up to 50-year government bonds were negative at one point. In the United States, yields on 10-year Treasuries have fallen close to the lowest levels marked after the global financial crisis; market participants seem to have various interpretations of the implication of an inverted yield curve, which has been observed since mid-August, with yields on 10-year Treasuries declining below those on 2-year Treasuries. In the meantime, major economies' central banks, such as the Federal Reserve and the European Central Bank (ECB), have shifted to a more accommodative policy stance so as to prevent uncertainties over the global economy from affecting domestic and regional economic activity and prices. In this respect, the Bank considers it important to thoroughly examine risks to overseas economies and carefully assess how those risks could affect Japan's economic activity and prices. Based on such examination, the Bank, like other central banks, will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. To clarify its intention, in the July 2019 Statement on Monetary Policy, the Bank presented its stance that it "will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost." Moreover, in the statement released on September 19, the Bank judged that it was becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target would be lost. Based on this judgment, it added an expression that, taking this situation into account, it would reexamine economic and price developments at the next MPM, when it will discuss the October Outlook Report. Actual economic conditions faced by central banks are extremely complex and change dynamically in the course of time. On this point, at the Jackson Hole symposium in 2018, there was discussion about implications for monetary policy arising from various structural changes that have occurred in recent years, including digital innovation and an increase in types of non-tangible assets such as software, intellectual property, and brand equity. Moreover, at the Jackson Hole symposium held this year, Federal Reserve Chairman Jerome Powell pointed to recent uncertainties as a new challenge for monetary policy management.3 In fact, a strengthening of protectionist moves recently appears to be one of the factors that makes the situation even more complicated. This economic symposium, held annually at Jackson Hole, Wyoming, in August, is hosted by the Federal Reserve Bank of Kansas City. Prominent central bankers, finance ministers, and academics from around the world convene to discuss topics such as on the global economy and monetary policy. I intend to continue to conduct monetary policy appropriately toward achieving the price stability target while considering all conceivable adverse effects and positive effects from every angle as well as taking full consideration of these notable changes in the environment and risks on which to place emphasis. See Jerome H. Powell, "Challenges for Monetary Policy: Remarks at a symposium hosted by the Federal Reserve Bank of Kansas City," Federal Reserve Bank of Kansas City, August 2019, https://www.federalreserve.gov/newsevents/speech/files/powell20190823a.pdf.
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Speech by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at the Japan Society, New York City, 3 October 2019.
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October 4, 2019 Bank of Japan Has Japan's Economy Changed?: Challenges and Prospects Speech at the Japan Society in New York (New York, October 3) Masazumi Wakatabe Deputy Governor of the Bank of Japan Introduction It is a great honor to have the opportunity to speak to you here at the distinguished Japan Society. Has Japan's economy changed? My answer is both yes and no. The economy has been changing in a positive manner, but the change is far from over. I would like to talk about changes in Japan's economy and its challenges from a somewhat longer-term perspective. "Because Japan has experienced decades-long stagnation, today's society is a very difficult place to live for you." This comes from a children's educational comic book published in August 2013.1 This phrase reflects the general mood back then, when the economy was under prolonged stagnation. About 30 years have passed since the early 1990s, when the asset price bubble collapsed in Japan. Looking back, this 30-year period can be roughly divided into three separate decades. In the first decade, aggregate demand fell after the collapse of the bubble economy, the so-called "three excesses" of corporate debt, production capacity, and employment materialized, and attention was drawn to the nonperforming loan problem of financial institutions. In the following decade, although the disposal of nonperforming loans proceeded on course, the economic growth rate remained low. Also, deflation became a problem, with the annual CPI inflation rate staying in negative territory. These two decades are sometimes called Japan's "lost two decades." And the last decade is the period from the early 2010s up to the present. As there has been lively discussion on why Japan's economy remained stagnant for such a long time as the "lost two decades" after the collapse of the bubble economy, I will not go into detail.2 Instead, as an introduction, I would like to discuss Japan's declining and aging Miyazoe Ikuo and Taira Takahisa, Shōgakukan-ban gakushū manga 2 Nishida Kitaro: Sekai ni eikyō o ataeta nihonjin hatsu no tetsugakusha, comp. Nishida Kitaro Museum of Philosophy (Tokyo: Shogakukan Inc., 2013), p.15. For my view, see Masazumi Wakatabe, Japan's Great Stagnation and Abenomics: Lessons for the World (New York: Palgrave Macmillan, 2015). population, which is considered to be not only one of the factors behind the "lost two decades" but also highly likely to continue. Japan's economy has faced the structural problem of a decline in working-age population since the mid-1990s. The total population started to decline in the 2010s, but the working-age population aged 15-64, which is the major source of labor supply, already began to decrease in the mid-1990s (Chart 1). In other words, since the mid-1990s, Japan has remained in a period of so-called demographic onus, where the working-age population declines at a faster pace than that of the total population. This stands in contrast to the United States, where both the total population and the working-age population have continued to increase consistently. The decline in the working-age population has been pointed to as one of the reasons behind the stagnant economic activity in Japan's "lost two decades." In fact, when we decompose Japan's potential growth rate into the number of employed persons, hours worked, capital stock, and total factor productivity (TFP), we can find that the number of employed persons contributed negatively from the late 1990s through the late 2000s (Chart 2).3 The decline in the working-age population is considered to lie behind this development. That said, I believe the negative effects on the economy of a declining and aging population have been rather exaggerated. First of all, as Chart 2 shows, the contribution of the number of employed persons is not so significant; capital stock and TFP contribute more to the potential growth rate. Historically speaking, throughout the post-WWII era, an increase in capital stock and TFP has contributed more than a change in labor input to a rise in the economic growth rate. Also, international comparisons show no evidence that a declining and aging population leads to a decline in per capita growth rate.4 In addition, there are a number of transmission mechanisms through which a declining and aging population can affect the economy (Chart 3). Admittedly, a decline in the working-age population could exert downward pressure on economic growth, since the labor supply will decrease. The potential growth rate here and the output gap, which will be discussed later in the speech, are based on estimates made by the Bank of Japan. The estimation results should be interpreted with a certain latitude. Using OECD data from 1970 through 2011, one study shows that there is no correlation between per capita GDP growth rate and population growth rate. See Hatta Tatsuo and Nippon Institute for Research Advancement, eds., Chihō sōsei no tame no kōzō kaikaku: Dokuji no yūisei o ikasu senryaku o (Tokyo: Jiji Press Ltd., 2018), p.7. Furthermore, investment may be reduced as firms and individuals expect continuous depopulation and slower economic growth accordingly. However, the impact of the decline in working-age population on the economy will not necessarily be negative. For example, in response to the decline, those who used to be outside the labor market may start working and their potential may be unlocked. If this happens, the positive impact on the economy can offset the negative impact. Also, firms may promote innovation and increase labor-saving investment in such areas as information and communication technology as well as artificial intelligence (AI) in order to make more effective use of scarce labor. If such developments improve the overall productivity, the economy can continue growing, even in the face of the structural problem of a declining and aging population. What has actually happened in Japan's economy in recent years? The economy was in a period of prolonged deflation in the second half of the "lost two decades," that is, from the late 1990s through the early 2010s (Chart 4). The output gap remained in negative territory for a long period, and the CPI continued to decline at an annual pace of around 0.4 percent on average. However, Japan's economy has improved significantly since the early 2010s, when the Bank of Japan introduced quantitative and qualitative monetary easing (QQE), which differs considerably from the past policy frameworks.5 The output gap has improved for the past few years, taking hold in positive territory. The economy is no longer in deflation in the sense of a sustained decline in the CPI. Thus, you can see that Japan's economic activity and prices have improved clearly, although the declining and aging population has continued to weigh on the economy in a structural manner. In the next part of this speech, let me describe the positive changes in Japan's economy, by comparing the present situation with the "lost two decades" or under deflation. I sometimes feel that many people do not necessarily have an accurate picture of the current state of Japan's economy since they have a deeply-entrenched negative image of the bubble burst and deflation as well as the current declining and aging population. Thus, I will elaborate on the positive changes in Japan's economy, in the hope that you will better understand the Masazumi Wakatabe, "Japan's Economy and Monetary Policy," speech at a meeting with business leaders in Aomori, June 27, 2019, http://www.boj.or.jp/en/announcements/press/koen_2019 /ko190627a.htm/. current situation. On that basis, I will also talk about the challenges. I personally think that economic growth and price stability can be achieved even given the structural problem of a declining and aging population. That said, it is true that there are many challenges to be tackled beforehand. I would like to share my opinions on these challenges, which should be addressed with a view to ensuring further strength in Japan's economy. I. Achievements and Changes I would like to talk about what kind of positive changes have taken place in Japan's economy, by comparing the situation now with the "lost two decades" or under deflation. A. Improvement in People's Lives First, let us take a look at changes in household income as a whole (Chart 5). Nominal disposable income did not increase for a long time following the late 1990s. During this period, real disposable income, adjusted for inflation, increased moderately because prices continued to decline somewhat. However, households could not feel the increase in their income as nominal disposable income did not increase. Since the mid-2010s, there has been a notable change, as disposable income has increased clearly in both nominal and real terms. How have people perceived this change (Chart 6)? In a public opinion survey, people were asked how satisfied they are with their current lives. The proportion of respondents answering that they were satisfied declined clearly from the late 1990s, to a level below that in the 1980s. However, it has increased notably since the early 2010s, and recently registered a record high. This improvement in people's satisfaction with their lives is likely due to an increase in their income stemming from economic improvement. In fact, in the same public opinion survey, the proportion of respondents answering satisfied with their income also rose significantly. To see how far economic improvement has spread to households, I would like to look at the poverty rate (Chart 7). The poverty rate for all households has peaked out in recent years, although it was previously on an uptrend. In particular, the child poverty rate has started to decline. Of course, there is room for improvement regarding the problem of poverty, but it is suggested that the improvement in financial conditions for a wide range of households is already happening gradually. B. Changes in Labor Market Conditions What lies behind the improvement in people's satisfaction with their lives? The answer is changes in labor market conditions (Chart 8). The unemployment rate has declined recently to around half the level of the deflationary period. Since the working-age population has continued to decline in Japan, some may suspect that this is just due to a decline in labor supply. You can see in this chart, however, that the improvement in the employment situation since the early 2010s has been accompanied by an increase in the number of employed persons. This implies that the recent tightening of labor market conditions is mainly due to an increase in labor demand, not a decline in labor supply. This improvement in the employment situation has brought about an increase in household income, with the number of employed persons increasing and wages rising moderately. Why has the number of employed persons been increasing despite the declining working-age population? The answer is a significant increase in labor participation by women and seniors. Chart 9 shows developments in the number of labor force participants and the labor force participation rates for working-age men and women as well as seniors aged 65 and over. The labor force participation rate for each group is defined as the ratio of labor force participants to the respective population. In the past few years, the labor force participation rate of working-age men has increased somewhat while being at a high level. Meanwhile, the number of labor force participants among this group has been decreasing, along with the decline in the overall working-age population. In contrast, the labor force participation rate of working-age women has been rising consistently. Through 2012, the number of labor force participants among this group decreased as the impact of the decline in the overall working-age population was large. Since 2013, however, the number has started to increase as labor participation by women has accelerated further. As for seniors, the number of labor force participants increased for a while after the mid-2000s along with a rise in the elderly population, even without a rise in their labor force participation rate. Since 2013, the number has been increasing at a faster pace, as seniors have become more active in participating in the labor market. As we have just seen, labor participation by women and seniors has increased considerably, and this is a significant change observed in the labor market since the early 2010s. What then has prompted more women and seniors to enter the labor market in Japan? In the case of women, I first need to explain the past situation of their labor participation (Chart 10). Looking at the labor force participation rate of women by age group, the so-called M-shaped curve was evident in the late 1990s, as the rate was lower at the life stage of childbirth and child-rearing. This is because, when working women in Japan reached this life stage, there was a strong tendency to give up continuing to work and leave the labor market. Recently, however, it can be said that women at this life stage continue to participate in the labor market, and therefore the curve is generally no longer M-shaped. For almost all age groups, women's labor force participation rates in Japan now exceed those in the United States. In Japan, women's labor participation has been encouraged by a rise in labor demand due to economic improvement as well as by enhancement of the surrounding environment through various measures taken by both the public and corporate sectors so that women can balance child-rearing and a career. In fact, local governments have increased the provision of nursery facilities, and firms have actively set up childcare centers at their workplace in an effort to avoid losing female employees who are raising children. More firms have offered further support for parental leave and introduced teleworking systems to allow employees to work at home without the burden of commuting. Thanks to these initiatives, fewer women now leave the labor market to raise children. Next, Chart 11 shows changes in the number of labor force participants among seniors, broken down into smaller age groups. You can see that labor participation has increased not only for those aged 65-69 but also for those aged 70 and over. This increase may be partly due to financial reasons such as the incremental rise in the pension age, but that alone is not a sufficient reason. As people get older, they tend to work for non-economic reasons, such as to find fulfillment in life or to make a social contribution. From another perspective, the slowing of physical aging seems to help seniors to continue working (Chart 12). Compared with a decade ago, for example, they have become physically younger by about 5 years based on their walking speed, and by about 10 years based on their number of teeth. These changes in physical ability mean that it is not unnatural for people to continue working in their 70s, even though a decade ago it was regarded as natural that they retire at the age of 65.6 In Japan, where the working-age population has been decreasing, an increase in labor participation by women and seniors is welcome in terms of accelerating economic growth. However, their labor force participation rates cannot exceed 100 percent. What we need to do now is to improve the productivity of the overall economy. I will come back to this later. C. Changes in Firms' Behavior Thus far we have looked at changes in the household sector, focusing on labor market conditions. Signs of change have also been seen in the corporate sector. Firms have proactively responded to labor shortages. Amid tight labor market conditions, firms have increased labor-saving investment to save human resources and have used capital as a substitute. In Japan's manufacturing sector, there has been active labor-saving investment. Based on the tough experience of surges in crude oil prices during two oil crises in the 1970s, manufacturers have taken initiatives since the 1980s to cut costs and streamline production processes, for example, by introducing production robots. In the face of globalization, large manufacturing firms exposed to severe competition, in particular, have continued to make such efforts. By contrast, in the nonmanufacturing sector, where many industries are labor-intensive, firms seemed less enthusiastic about undertaking labor-saving investment. This is partly because they were able to take advantage of a stable supply of low-wage workers, such as part-timers, and did not face such fierce global competition. However, reflecting the recent tight labor market conditions, labor-intensive nonmanufacturers have begun working toward saving labor (Chart 13). Since the early 2010s, labor-intensive industries such as "construction," "retailing," and "accommodations, eating and drinking services" have been actively making labor-saving investment, as you Toshitaka Sekine, "Does Demography Really Matter?," presentation at the G20 Symposium titled "For a Better Future: Demographic Changes and Macroeconomic Challenges," January 17, 2019, https://www.g20fukuoka2019.mof.go.jp/ja/meetings/pdf/S1-1_Toshitaka%20Sekine.pdf. A study in the United States shows that the average age of the founders of the top 0.1 percent fastest-growing start-up firms is 45. See Pierre Azoulay et al., "Age and High-Growth Entrepreneurship," NBER Working Paper, no.24489, 2018. can see from the clear increase in their software investment. For example, even at small restaurants in Japan, you can find tablet computers at your table allowing you to order just by tapping. This kind of system helps restaurants to save labor in taking orders from customers and improve efficiency in sales management. Construction sites, which have also faced labor shortages, have been adopting new technologies. One example is the introduction of survey systems using drones. Another is the use of AI to analyze accumulated information to complement operations which used to rely largely on skilled workers' experience. The clear rise in labor productivity since the early 2010s appears to reflect these initiatives by firms, enabled by remarkable technological progress in recent years. The changes that I have just outlined may be seen as a passive response to labor tightening, but you can find more proactive initiatives (Chart 14). There has been a steady increase in the number of mergers and acquisitions (M&As) made by Japanese firms, although their total value has fluctuated considerably due to some large-scale M&As. Moreover, although the firms' entry rate was low during the "lost two decades," it seems that there have been signs of a rise recently, albeit at a lower level than that of the United States. I think that the expansion of such initiatives can be seen as a positive change for Japanese firms, which used to be considered cautious about taking risks after the collapse of the bubble economy. II. Challenges Ahead So far, I have talked about the positive changes in Japan's economy after the "lost two decades." Its growth potential, however, needs to be further enhanced. Moreover, we are still only halfway toward achieving the Bank of Japan's price stability target of 2 percent. I think that there are still many challenges to be addressed in raising Japan's growth potential. In the remaining part of my speech, I would like to focus on the challenges toward raising productivity in Japan's economy amid a declining and aging population. In order to improve productivity, it is necessary to invest in human resources so that more and more people can enhance their knowledge and skills. It is also important to create and maintain an "open" economic and social system that encourages people to make the best use of their abilities. A. Expected Changes in the Corporate Sector As I mentioned earlier, firms' efforts to raise labor productivity by, for example, making labor-saving investment have spread not only to the manufacturing sector but also to the nonmanufacturing sector. However, even if labor productivity rises, there is no guarantee that the overall productivity of the economy, including capital productivity, will increase. Let us consider the case where capital, such as robots, substitutes for labor. If this is a mere substitution of one unit of labor with one unit of capital and the value added remains the same, the overall productivity will not change substantially because labor productivity will rise while capital productivity declines. In fact, developments in TFP of various production factors, including the effective use of capital, have differed from developments in labor productivity growth, which has increased significantly (Chart 15). TFP growth has been relatively high in the IT-producing sector, such as for manufacturers of electronic parts and electrical machinery. In contrast, growth has been sluggish in the IT-using sector, which includes most of the nonmanufacturing industries with a high ratio of software investment to overall investment, such as "information and communications," "transport and postal services," as well as "wholesale and retail trade." While the deceleration in TFP growth has become a common concern among advanced economies, TFP growth has remained low in Japan's IT-using sector since the 2000s. Among the many hypotheses proposed to explain this low growth, I would like to focus on the stance of Japanese firms toward the use of IT. According to a survey asking Japanese firms why they have increased their IT-related budget, many answered that it was to improve business efficiency and cut costs. This is in contrast with U.S. firms, which have incorporated new technologies to encourage innovative initiatives such as developing products and services. Although an increasing number of Japanese firms have recently started to try new technologies, not many seem to have made them work for successful innovation. New technologies, such as AI and the Internet of Things (IoT), continue to make rapid progress. I hope that Japanese firms will adopt these technologies not only to cut costs and streamline production processes, which they are good at, but also make more active use of them to enhance the value added through innovation. B. Expected Changes in the Household Sector: Further Active Participation by Women and the Young Then, what changes are expected in the household sector with a view to improving productivity? As I pointed out earlier, the increased labor participation by women and seniors is a very positive development for Japan's economy, given the decline in the working-age population. The next step is to fully unlock people's potential. In the following, I would like to focus on the challenges toward encouraging a greater contribution by women and the young. Let me start with the issue of unlocking women's potential. I would like to first look at developments in the income levels of men and women over their lifetime (Chart 16). We can see that women's income level clearly falls behind men's as they get older. One possible reason is that, in the past, the university enrollment rate of women was relatively low compared to that of men. Another reason is that women may have less chance to develop their job skills, since they tend to give up continuing to work in order to raise children.7 With regard to women's job skills, I would like to show an analysis of the gap in literacy between men and women (Chart 17). Across countries, there is no significant gender gap in the levels of literacy. As for the frequency of skill use in the workplace, however, the gender gap is more evident in Japan than in other countries. In Japan, women use their literacy at work much less frequently than men, suggesting that women are less likely to be assigned highly-skilled tasks.8 As these observations imply, I think that women's potential has not yet been fully unlocked in Japan (Chart 18). For example, while the proportion of women to total employed persons is comparable to that of other countries, the proportion of women in managerial positions is clearly lower. In addition, surveys on the underutilization of labor show that many women wish to increase their working hours, particularly middle-aged women who have completed Lorraine Dearden and Nobuko Nagase, "Getting Student Loans Right in Japan: Problems and Possible Solutions," Discussion Paper Series A of the Institute of Economic Research at Hitotsubashi University, no.668, 2017. Daiji Kawaguchi and Takahiro Toriyabe, "Parental Leaves and Female Skill Utilization: Evidence from PIAAC," RIETI Discussion Paper Series, no.18-E-003, 2018. the early stages of child-rearing. There seems to be quite a few women who want to return to a full-time job after child-rearing but are unable to do so. Given the declining and aging population in Japan, it is essential that women not only enter the labor market but use their abilities to the fullest extent. Is Japan heading in this direction (Chart 19)? With regard to the educational environment before becoming employed, 30 years ago the percentage of women enrolled in a four-year university was only about half of that of men, but in recent years it has risen to a level comparable to that of men. Thus, as for pre-employment education, it can be said that the gender gap has been generally eliminated. In addition, although the employment rate for women tended to be lower than that for men, it has recently exceeded that for men. Moreover, an increasing number of firms have been providing learning opportunities for women during their parental leave so that they can maintain and improve their skills. There has also been an increase in firms' initiatives to share work-related information with women on parental leave so that they can catch up more easily when they return to work. As these examples show, it seems that an environment is being created to encourage women to make full use of their abilities. Of course, there are still many women who have completed their child-rearing but have given up on rejoining the labor market. It is also important to provide these women with recurrent education to enable them to improve their skills and take positions requiring high skills when they re-enter the labor market. Next, I would like to move on to the young. From a long-term perspective, education is extremely important in improving productivity. Macroeconomic productivity benefits from creating an environment that enables children to become better educated regardless of their economic conditions by, for example, providing free education. Given the globalization of corporate activities, education is also key to developing internationally competent talent. On this point, I would like to show you some data regarding the number of Japanese students studying abroad (Chart 20). The percentage of Japanese students enrolled in foreign schools peaked out in the 2000s. However, the number of students studying abroad for shorter periods while enrolled at Japanese universities has continued to increase. This data can be viewed in a number of ways, but I think the fact that an increasing number of young people in Japan have experienced studying abroad, even if only for a short time, can be seen as the first step in fostering more skilled individuals ready for a globalized world. However, there is still room for improvement in Japan with regard to enrollment in graduate schools. The proportion of female graduates at Ph.D. level is 31 percent for Japan, the lowest among the OECD countries, where the average is 47 percent.9 Let me briefly talk about Japan's financial sector in relation to the asset building of households. Japan's household financial assets have increased steadily, reaching 1,860 trillion yen at the end of June 2019. In this situation, there have been changes in both the household and financial sectors. Households' investment in financial assets other than deposits has been gradually observed. The financial industry is one of the industries that have been affected by the structural factor of a declining and aging population amid the economic improvement. However, it has also seen steady progress in globalization and technological innovation. Japanese financial institutions are increasingly extending their overseas operations and making alliances with a wide variety of businesses, including so-called FinTech firms, to offer new services to customers. Conclusion Today, I have talked about the positive changes in Japan's economy and future challenges from a somewhat longer-term perspective. Hopefully you have gained the impression that Japan's economy has continued to grow after the "lost two decades." Women and seniors' labor participation as well as firms' initiatives to increase labor-saving investment have offset the negative impact of the declining population. However, the declining and aging population will continue to weigh on Japan's economy. For the economy to continue growing under such circumstances, it is essential to further increase productivity. Japan still has untapped potential and room to reform and improve in many fields. Once we unlock our potential to the fullest extent, we can overcome the challenges. OECD, "Country Note: Japan" in Education at a Glance 2019: OECD Indicators, 2019, https://www.oecd.org/education/education-at-a-glance/EAG2019_CN_JPN.pdf. Let me conclude my speech by sharing my thoughts on the links between monetary policy and the enhancement of economic growth potential, as well as the role of central banks. Economic growth potential is supposed to be enhanced mainly by changes in the behavior of private entities with the support of the government's growth policy. Meanwhile, the Bank of Japan's monetary policy aims at achieving the price stability target of 2 percent, and there are synergy effects between the efforts of various economic entities and the Bank's monetary policy. The expected growth rate of Japan's economy is likely to rise as private firms actively undertake investment in capital and human resources as well as innovation. It is also likely to rise as the government establishes a business environment that encourages such investment and makes beneficial public spending, including on education and the promotion of science and technology. As the expected growth rate rises, firms' investment and households' consumption will be encouraged further, thereby ensuring the path toward achieving the price stability target of 2 percent. At the same time, I think that monetary easing itself can in turn contribute to enhancing the growth potential in some ways.10 One way is that, as monetary easing has made clear the problems of labor shortages and supply constraints resulting from demand increase, it has consequently highlighted the issue of Japan's growth potential that lies behind these problems. Although a decline in the growth potential has long been recognized as a challenge of Japan's economy, it was not seen as an immediate issue when the economy faced deficient demand. It was not until labor shortages and supply constraints materialized due to the increase in demand that people actually started to take concrete action toward enhancing the growth potential and increasing the economy's supply capacity. People acquire skills through their daily work, thereby raising their productivity. In particular, whether or not young people have opportunities to enhance their skills at work affects their future careers, as well as the productivity of the overall economy. It is vital that the younger generation is provided diverse and stable job opportunities. A decline in the long-term unemployment rate also increases the economy's productivity, since skills could be lost as unemployment becomes prolonged. Widespread improvements in the labor market are Masazumi Wakatabe, "Japan's Economy and Monetary Policy," speech at a meeting with business leaders in Niigata, December 5, 2018, http://www.boj.or.jp/en/announcements/press/koen_2018 /ko181205a.htm/. likely to raise the growth potential of Japan's economy. Another possible contribution of monetary easing is to encourage firms to become more active. With the experience of prolonged deflation, Japanese firms have been cautious about taking risks and have remained persistently prudent toward business investment and wage increases. I believe that, if our monetary policy improves overall economic activity, it will encourage firms to change their behavior premised on deflation and take positive initiatives toward making active investment and raising productivity further.11 Japan has experienced stagnation and deflation for a long time. The Bank of Japan aims at achieving price stability, thereby contributing to the sound development of the national economy. From now on, when a children's book is written, I would prefer not to see a phrase such as "it is a very difficult place to live because there has been a decades-long stagnation." Thank you for your attention. There are arguments that the stabilization of the macroeconomy in the short term affects economic growth in the long term. For details, see Bank of Japan, Research and Statistics Department, "Minutes of the 7th Joint Conference Organized by the University of Tokyo Center for Advanced Research in Finance and the Bank of Japan's Research and Statistics Department: New Developments in Macroeconomic Analysis: Interaction between Business Cycles and Economic Growth," BOJ Reports and Research Papers, 2018, http://www.boj.or.jp/research/brp/ron_2018 /ron180330a.htm/ (available only in Japanese); and Souhei Kaihatsu et al., "Interaction between Business Cycles and Economic Growth," Bank of Japan Working Paper Series, no.18-E-12, 2018, http://www.boj.or.jp/en/research/wps_rev/wps_2018/wp18e12.htm/. Has Japan's Economy Changed?: Challenges and Prospects Speech at the Japan Society in New York October 3, 2019 Masazumi Wakatabe Deputy Governor of the Bank of Japan Outline Introduction I. Achievements and Changes II. Challenges Ahead Conclusion Chart 1 Introduction Demographics Working-Age Population (Aged 15-64) Total Population 2.0 y/y % chg. 2.0 y/y % chg. United States United States 1.5 1.5 Japan 1.0 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 -1.0 -1.0 -1.5 -1.5 -2.0 CY80 -2.0 CY 80 Japan Source: OECD. Chart 2 Introduction Potential Growth Rate Recent Developments y/y % chg. Developments in the 60s-80s average y/y % chg. Labor Number of employed persons Hours worked Capital stock Total factor productivity Real GDP growth rate Capital stock Total factor productivity Potential growth rate -1 -2 FY 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Notes: 1. In the left chart, figures are based on BOJ staff estimates. Notes: 2. In the right chart, figures are from the "White Paper on International Economy and Trade 1998." Sources: Ministry of International Trade and Industry; Bank of Japan. 60s 70s 80s Chart 3 Introduction Possible Transmission Mechanisms Declining and aging population Declining and aging population Working-age population Growth expectation Economic Growth Investment Labor participation Labor-saving investment Productivity Economic Growth Note: See Carlos Carvalho, Andrea Ferrero, and Fernanda Nechio, "Demographics and Real Interest Rates: Inspecting the Mechanism," Federal Reserve Bank of San Francisco Working Paper 2016-05; Nao Sudo and Yasutaka Takizuka, "Population Aging and the Real Interest Rate in the Last and Next 50 Years: A Tale Told by an Overlapping Generations Model," Bank of Japan Working Paper Series, no.18-E-1, 2018; and Haruhiko Kuroda, "Demographic Changes and Challenges for Financial Sector," remarks at the Paris EUROPLACE Financial Forum in Tokyo, 2018. Chart 4 Introduction Improvements in Japan's Economy Output Gap Consumer Prices % CPI (less fresh food) CPI (less fresh food and energy) -2 -4 -1 -6 -2 -8 CY 85 y/y % chg. Notes: 1. In the left chart, the output gap is based on BOJ staff estimates. Notes: 2. In the right chart, figures are adjusted for changes in the consumption tax rate. Sources: Bank of Japan; Ministry of Internal Affairs and Communications. -3 CY 85 Average after 2013/Q2 + 0.5% Average from 1998/Q2 to 2013/Q1 (less fresh food and energy) - 0.4% Chart 5 I. Achievements and Changes Increase in Disposable Income FY 2010 = 100 Nominal Real FY 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Source: Cabinet Office. Chart 6 I. Achievements and Changes Levels of Satisfaction with Life % % Ratio of respondents satisfied with their lives (left scale) Ratio of respondents satisfied with their income (right scale) CY 65 Note: There is a discontinuity in the data for the 2016 survey due to a change in respondents' age coverage. (The old series covers those aged 20 and over, while new series covers those aged 18 and over.) Source: Cabinet Office. Chart 7 I. Achievements and Changes Poverty Rate % Relative poverty rate for children Relative poverty rate for all households CY85 Note: The relative poverty rate is defined as the proportion of people with an equivalent disposable income (i.e., disposable income per household divided by the square root of the number of household members) below the poverty line, which corresponds to half the median of equivalent disposable income. The relative poverty rate for children is defined as the proportion of children (aged 17 and under) below the poverty line. Source: Ministry of Health, Labour and Welfare. Chart 8 I. Achievements and Changes Recent Labor Market Conditions Working-Age Population and Number of Employed Persons Unemployment Rate s.a., % Average from 1998 through 2012: 4.6% mil. persons August 2019: 2.2% CY 75 Unemployed persons Employed persons Population aged 15-64 Source: Ministry of Internal Affairs and Communications. CY 75 Chart 9 I. Achievements and Changes Breakdown of Changes in Labor Force Participants Men (Aged 15-64) 0.0 change from CY 2000, mil. persons Seniors (Aged 65 and over) Women (Aged 15-64) % 1.4 change from CY 2000, mil. persons 1.2 -0.5 1.0 -1.0 % Labor force participants (left scale) Labor force participation rate (right scale) 0.6 0.4 0.2 0.0 82 -0.2 -0.4 -2.0 -2.5 -3.0 -3.5 Labor force participants (left scale) Labor force participation rate (right scale) -4.0 -4.5 CY 00 02 04 06 08 10 12 14 16 18 change from CY 2000, mil. persons 80 -0.6 CY 00 02 04 06 08 10 12 14 16 18 % Labor force participants (left scale) 0.8 -1.5 Labor force participation rate (right scale) -1 CY 00 02 04 06 08 10 12 14 16 18 Note: Figures for 2019 are January-July averages on a seasonally adjusted basis. Source: Ministry of Internal Affairs and Communications. Chart 10 I. Achievements and Changes Labor Force Participation by Women Women Wishing to Work and Capacity of Nursery Schools Women's Labor Force Participation Rate by Age % mil. persons 1.6 mil. persons Not seeking a job because of housework or child-rearing (left scale) Capacity of nursery schools, etc. (right 1.4 scale) 3.0 1.2 2.6 1.0 2.4 0.8 2.2 0.6 2.0 2.8 Japan (CY 1998) Japan (CY 2018) United States (CY 2018) Age 15- 20- 25- 30- 35- 40- 45- 50- 55- 60- 6519 0.4 FY 02 1.8 Notes: 1. In the left chart, the figure for those aged 15-19 in the United States is that for those aged 16-19. Notes: 2. In the right chart, figures for those "not seeking a job because of housework or child-rearing" for fiscal 2019 are for 2019/Q2 on a seasonally adjusted basis. There were revisions to the question (from "because of housework or child-rearing" to "because of childbirth or child-rearing") in 2013/Q1, and to the definition of "women not seeking a job" in 2018/Q1. Sources: Ministry of Internal Affairs and Communications; ILO; Ministry of Health, Labour and Welfare. Chart 11 I. Achievements and Changes Labor Force Participation by Seniors Labor Force Participants among Seniors change from CY 2000, mil. persons % Aged 75 and over (left scale) % Aged 70-74 (left scale) Aged 65-69 (left scale) Reasons for Working Labor force participation rate (right scale) -1 CY 00 Age 18-29 30-39 40-49 50-59 60-69 70Do not know To find fulfillment in life To demonstrate my talents and capabilities To fulfill my responsibility as a member of society To earn money Note: In the left chart, figures for 2019 are January-July averages on a seasonally adjusted basis. Sources: Ministry of Internal Affairs and Communications; Cabinet Office. Chart 12 I. Achievements and Changes Evidence of Slowdown in Physical Aging Average Number of Teeth Average Walking Speed 1.45 meters/second 5 years younger! number of teeth 1.42 10 years younger! 1.40 1.38 1.37 CY 2007 CY 2017 CY 2005 CY 2016 1.35 1.33 1.30 1.30 1.25 1.21 1.20 1.15 1.10 Age 65-69 70-74 75-79 Age 65-69 70-74 75-79 Notes: 1. See Toshitaka Sekine, "Does Demography Really Matter?," presentation at the G20 Symposium titled "For a Better Future: Demographic Changes and Macroeconomic Challenges," 2019. Notes: 2. In the left chart, average walking speed is the arithmetic average of men's and women's walking speeds. Sources: National Center for Geriatrics and Gerontology; Ministry of Health, Labour and Welfare. Chart 13 I. Achievements and Changes Labor-Saving Investment Increase in Software Investment in Labor-Intensive Industries Rise in Labor Productivity FY 2005 = 100 All industries Construction Retailing Accomodations, eating and drinking services s.a., average from CY 1980 onward = 100 FY 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 CY 85 Notes: 1. In the left chart, figures for software investment for fiscal 2019 are based on the investment plans in the June 2019 survey. Notes: 2. In the right chart, labor productivity = (operating profits + personnel expenses + depreciation expenses) / number of workers / GDP deflator Sources: Ministry of Finance; Cabinet Office; Bank of Japan. Chart 14 I. Achievements and Changes Firms' Positive Initiatives Firms' Entry Rate Number of M&As 2,500 number of M&As tril. yen % Total value (right scale) 2,000 Number of M&As (left scale) 1,500 1,000 Employment insurance basis (FY) Business establishments basis (CY) Incorporation registration basis (CY) 16-18 14-16 12-14 09-12 06-09 04-06 01-04 99-01 96-99 94-96 91-94 89-91 86-89 CY 07 08 09 10 11 12 13 14 15 16 17 18 19 81-86 Notes: 1. In the left chart, figures include only M&As in which Japanese firms are acquirers. Figures for the first half of 2019 are actual while those for the second half are estimated assuming that the year-on-year growth rates are the same as those for the first half. Notes: 2. In the right chart, for figures based on employment insurance, entry rate = number of business establishments newly covered by employment insurance / number of business establishments covered by employment insurance at the end of previous fiscal year × 100. For figures based on business establishments, entry rate = number of newly established business establishments / number of existing business establishments at the beginning of the year. For figures based on incorporation registration, entry rate = number of incorporation registrations / number of firms in previous year × 100. To allow for comparison, period averages of figures based on employment insurance and incorporation registration are calculated in line with those based on business establishments, which is least frequently surveyed. Sources: Bloomberg; The Small and Medium Enterprise Agency; Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Ministry of Justice; National Tax Agency. Chart 15 II. Challenges Ahead Toward Productivity Enhancement: IT Utilization TFP Growth Rates of IT-Producing Sector and IT-Using Sector annualized average growth rate, % Reasons for IT Investment Aggressive Defensive Prompt responses to Regular system changes in markets/customers Use of new technologies updates /products/services Introduction of IT to non-IT business processes All sectors 1.0 1.1 -0.2 0.9 Innovation in business models using IT Japan 2017 Greater business efficiency /cost cut using IT Enhanced development of products/services using IT IT-producing sector 8.4 9.0 7.7 United States 2013 Japan 2013 3.9 Expansion in firm size IT-using sector 1.3 1.5 -0.6 Enhanced analysis of customer behavior/markets using IT Responses to laws and regulations Expansion in business operations /product lines Increasing sales Increasing profits 0.5 Notes: 1. In the left chart, TFP is measured by using SNA data classified by economic activity in the "Annual Report on National Accounts." IT-producing sector is composed of electronic components and devices; electrical machinery, equipment and supplies; and information and communication electronics equipment. IT-using sector is composed of 9 industries in which the ratio of software investment to GDP is relatively high: information and communications; transport and postal services; wholesale and retail trade; accommodation and food service activities; professional, scientific and technical activities; electricity, gas and water supply and waste management service; chemicals; textile products; other manufacturing. 2. In the right chart, figures are based on the 2017 JEITA/IDC Japan survey. Sources: Cabinet Office; JEITA. Chart 16 II. Challenges Ahead Gender Gaps in Income Annual Income (Middle-Class) mil. yen Men Women Age 23 Source: Lorraine Dearden and Nobuko Nagase, "Getting Student Loans Right in Japan: Problems and Possible Solutions," Discussion Paper Series A of the Institute of Economic Research at Hitotsubashi University, no.668, 2017. Chart 17 II. Challenges Ahead Gender Gaps in Skills and Skill Use Literacy Skill Use Literacy Notable gap in Japan 0.4 0.2 0.2 0.0 0.0 Gender gap 0.4 -0.2 -0.2 -0.4 -0.6 -0.6 -0.8 -0.8 AUT BEL CAN CHL CYP CZE DNK EST FIN FRA DEU GRC IRL ISR ITA JPN KOR LTU NLD NZL NOR POL SGP SVK SVN ESP SWE TUR GBR USA -0.4 AUT BEL CAN CHL CYP CZE DNK EST FIN FRA DEU GRC IRL ISR ITA JPN KOR LTU NLD NZL NOR POL SGP SVK SVN ESP SWE TUR GBR USA Gender gap No significant difference between countries Note: Figures show unconditional gender gaps in skills and skill use. Each point represents the gender gap, and the bars indicate its 95% confidence interval. Source: Daiji Kawaguchi and Takahiro Toriyabe, "Parental Leaves and Female Skill Utilization: Evidence from PIAAC," RIETI Discussion Paper Series, no.18-E-003, 2018. Chart 18 II. Challenges Ahead Labor Underutilization Proportion of Employed Women and Women in Managerial Positions % Labor Underutilization by Gender and Age (2019/Q2) Employed persons Available potential jobseekers Managers thousand persons Employed persons in timerelated underemployment Men 65 and over 55-64 45-54 35-44 25-34 15-24 65 and over 55-64 45-54 35-44 25-34 15-24 Norway Sweden Germany France UK US Japan Age Women Notes: 1. In the left chart, the definition of "managers" varies across countries. In Japan, managers include corporate executives, managerial personnel equivalent to or above section chief, and managerial government officers. Notes: 2. In the right chart, "employed persons in time-related underemployment" means employed persons with weekly working hours of less than 35 hours who are wishing and able to work additional hours. "Available potential jobseekers" means those who have not been seeking a job within one month, but who are wishing and ready to work if work is available. Sources: Ministry of Internal Affairs and Communications; ILO. Chart 19 II. Challenges Ahead Enrollment Rate and Employment Rate Employment Rate for University and High School Graduates University Enrollment Rate % % Men 56.6 Women 50.7 33.4 15.2 Men Women CY60 CY97 99 01 03 05 07 09 11 13 15 17 19 Sources: Ministry of Education, Culture, Sports, Science and Technology; Ministry of Health, Labour and Welfare. Chart 20 II. Challenges Ahead Globalization of Human Resources Japanese Students Studying Abroad Temporarily Japanese Students in Higher Education Abroad % thousand persons 0.40 0.35 thousand persons 0.30 % Less than one month (left scale) From one month to less than one year (left scale) One year or longer (left scale) Number of students studying abroad (left scale) Ratio to population aged 15-29 (right scale) 0.7 0.6 0.5 0.4 0.3 0.2 0.05 0.1 0.00 FY 09 0.25 0.20 0.15 Number of students studying abroad (left scale) Ratio to population aged 15-29 (right scale) CY83 0.10 0.0 Note: In the left chart, there is a discontinuity in the data for the 2013 survey due to a change in the definition of "students studying abroad." Sources: Ministry of Education, Culture, Sports, Science and Technology; OECD; UNESCO; Institute of International Education; Japan Student Services Organization, etc.
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Keynote speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the ASIFMA Annual Conference 2019, Tokyo, 10 October 2019.
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October 10, 2019 Bank of Japan Development of Asia's Capital Markets: Roles and Challenges Keynote Speech at the ASIFMA Annual Conference 2019 Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction Good morning everyone. It is my great pleasure to be here at the Asia Securities Industry and Financial Markets Association (ASIFMA) annual conference 2019. I am honored to address this distinguished audience comprised of representatives from the securities and asset management industries, institutional investors, policy makers, and regulators in Asia and other important regions. Asia's capital markets have experienced remarkable growth since the Asian financial crisis in the late 1990s. Asia's share of global stock market capitalization1 soared from 1 percent in 2000 to 15 percent in 2017. Notably, the amount outstanding in local currency bond markets in Asia as a share of GDP2 in 2018 increased to more than double that in 2000 (Chart 1). Obviously, the rapid expansion of Asian economies has driven the growth of the capital markets in the region. At the same time, the collective efforts of market participants, policy makers, and regulators both at national and regional levels have contributed to market liberalization and enhancement of market infrastructures in Asia. Typical examples of such regional cooperation include the Asian Bond Markets Initiative (ABMI), launched by the ASEAN+3, as well as the Asian Bond Fund (ABF) initiative3 of the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP), which is a group of 11 central banks and monetary authorities in the region. Financial industry associations, such as the ASIFMA, have also played a vital role by facilitating dialogue between market participants, promoting regional coordination, and providing necessary recommendations Based on figures for "East Asia & Pacific" (a country and region grouping employed in the World Bank's World Development Indicators) excluding high-income countries and regions (Australia, Hong Kong, Japan, South Korea, New Zealand, and Singapore). 2 Based on the aggregated amount outstanding in local currency bond markets in China, Hong Kong, India, South Korea, Malaysia, the Philippines, Singapore, Thailand, and Vietnam. 3 The Asian Bond Fund (ABF), established in 2003, is an index bond fund with a two-phase framework, namely, "ABF1," which invested in U.S. dollar bonds, and "ABF2," which invests in local currency bonds and is open to private sector investors. In 2016, because the EMEAP determined that ABF1 had achieved its original purpose, its proceeds were reinvested in ABF2. In July 2018, some selected bonds held within ABF2 were made available for lending to support the development of local currency securities lending markets and to enhance the functioning of regional money markets. from a market perspective. Activities by those market participants and relevant authorities have been indispensable for the development of Asia's capital markets. I would like to recognize and praise all of those who have committed to these efforts. Looking to the future, Asia needs to further accelerate and deepen the development of its financial markets more than ever before. This is because the existence of more developed capital markets both domestically and regionally will play a much more crucial role for the long-term stable economic growth of the region. Today, I would like to discuss the economic implications of the conference theme, "developing Asia's capital markets," from several perspectives. Then, I will briefly touch on interest rate benchmark reform, as a specific example of the challenges we are facing as we endeavor to further develop market infrastructures. Economic Significance of Further Developments in Asia's Capital Markets Financing Economic Growth through the Growing Middle-Income Class Let me begin with the importance of relying on the growing middle-income class to finance economic growth. The middle-income class in Asia has been growing to a remarkable extent. The Organisation for Economic Co-operation and Development (OECD) forecasts4 that the middle-income population in Asia will constitute 66 percent of the world's share in 2030, more than doubling that in 2009 (Chart 2). The rise of Asia's middle-income class will be accompanied by growth and diversification of the financial needs of that class. Both domestic and regional markets in Asia must satisfy those evolving demands by providing various financial services, including investment trusts, pension funds, and insurance. By doing so, Asia will receive benefits such as inflows of money from the middle-income class into infrastructure projects, which require a significant amount of funding. In other Kharas, H. (2010), "The Emerging Middle Class in Developing Countries," OECD Development Centre Working Paper, No. 285. words, meeting the financial demands of the growing middle-income class will contribute to utilization of Asian savings for Asian investments. Strengthening Financial Stability with More Liquid Domestic Capital Markets Now, I would like to proceed to a perspective of financial stability. Since the Asian financial crisis, many countries in the region have made wide-ranging efforts, including a reduction in the non-performing loans held by banks, in order to enhance their resilience against capital flow dynamics. However, the presence of domestic bond markets in the Asian financial system is still limited, compared with that of banking sectors. In order to further strengthen financial stability in Asia, it is important to diversify funding sources for firms by developing domestic bond markets.5 Recent empirical studies6 point out that domestic bond markets in East Asia provided an alternative source of funding for firms in the region when the liquidity of international debt markets vanished during the global financial crisis from 2008 to 2009. East Asia saw greater domestic bond issuance during the crisis, in contrast with lower international bond issuance and a reduction in the amount of syndicated loan origination (Chart 3). This result tells us how important it is to develop domestic bond markets to make the Asian financial system more robust. Enhancing the Effectiveness of Monetary Policy Lastly, I will touch on the effectiveness of monetary policy. For the conduct of monetary policy, central banks buy and sell financial instruments from capital markets, and they also receive financial instruments as collateral for the provision of liquidity. So, the degree of market functioning and liquidity concerning those financial instruments is a critical element that impacts the effectiveness of monetary policy. For example, see Bank for International Settlements (2016), "A Spare Tire for Capital Markets: Fostering Corporate Bond Markets in Asia," BIS papers, No. 85, which focuses on the importance of domestic bond markets among capital markets in times of crisis. 6 Abraham, F., J. J. Cortina, and S. L. Schmukler (2019), "The Rise of Domestic Capital Markets for Corporate Financing: Lessons from East Asia," World Bank Group Policy Research Working Paper, No. 8844. In this regard, repos are financial instruments that are frequently used in the conduct of monetary policy, because repos carry a low credit risk and they are suitable for inventory and liquidity management by market makers. In Asia, market participants have preferred to use FX swaps and uncollateralized funding because of their accessibility and operational convenience, and the role of repo markets has been relatively limited overall. However, the situation is now changing. The EMEAP market survey7 suggests ongoing efforts to enhance the functioning and liquidity of money markets such as repos. These efforts are being driven by various initiatives, such as the promotion of non-bank participation and the enhancement of industry standards. Accelerating these efforts would lead to greater effectiveness of monetary policy in Asia. Interest Rate Benchmark Reform Before closing, I will comment on interest rate benchmark reform. It would be beneficial to share some key points of interest related to this issue, as there are active discussions in various markets throughout the world. In the wake of the LIBOR manipulation scandal, more reliable and robust interest rate benchmarks have been pursued. In addition, LIBOR will most likely be permanently discontinued after the end of 2021 judging from the announcement by the U.K. Financial Conduct Authority in July 2017 that the survival of LIBOR cannot be guaranteed. LIBOR is the most widely-used benchmark in the global financial system and its discontinuation would have a significant impact on Asian markets. For example, the transition from U.S. dollar LIBOR to an alternative risk-free rate would be necessary in cases where the U.S. dollar is funded via cross-currency swaps. Accordingly, the other leg of the swap could also be affected. We should also bear in mind that the discontinuation would affect a wide range of market For details, see EMEAP Working Group on Financial Markets (2018), "EMEAP Money Markets: Survey Report." participants in Asia. The latest EMEAP report8 on a survey among member central banks on this issue stresses the importance of raising awareness of the potential discontinuation of LIBOR among institutional investors and non-financial corporates in particular. In Japan, initiatives to prepare for the possible discontinuation of Japanese yen LIBOR have been taken by the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks. The Bank of Japan serves as Secretariat on the committee, which is composed of a wide range of parties including financial institutions, institutional investors, and non-financial corporates. The committee has also expanded its deliberations into a public consultation and a wide range of outreach activities, such as holding a forum for non-financial corporates and industry associations (Chart 4). As a result, market awareness has been gradually growing and proactive initiatives towards interest rate benchmark reform, such as LIBOR exposure mapping, have been launched. The permanent discontinuation of LIBOR would be one of the most significant events in global financial history, and the deadline is unavoidable. It is therefore important for us all to work together for our common interest -- a smooth transition to alternative reference rates. We should bring together our cross-sectorial wisdom and experience towards establishing more reliable and robust interest rate benchmarks, and make interest rate benchmark reform one of the great successes in global financial history. Concluding Remarks This conference covers so many important topics related to financial developments in Asia. I hope that lively discussions and exchanges of viewpoints over the coming two days will further contribute to the development of Asia's capital markets. Thank you very much for your attention. For details, see EMEAP Working Group on Financial Markets (2019), "Study on the Implications of Financial Benchmark Reforms." Development of Asia's Capital Markets: Roles and Challenges Keynote Speech at the ASIFMA Annual Conference 2019 October 10, 2019 Masayoshi Amamiya Deputy Governor of the Bank of Japan Chart 1 Asia's Capital Markets Amount Outstanding of Local Currency Bond Markets as a Share of GDP Share of Global Stock Market Capitalization % 1% 15% 99% 85% East Asia & Pacific (excluding High Income) Rest of the World Notes: 1. In the left-hand chart, "East Asia & Pacific (excluding High Income)" covers the "East Asia & Pacific" (a country and region grouping employed in the World Bank's World Development Indicators) excluding high-income countries and regions (Australia, Hong Kong, Japan, South Korea, New Zealand, and Singapore). 2. In the right-hand chart, the figures are based on the aggregated amount outstanding of local currency bond markets in China, Hong Kong, India, South Korea, Malaysia, the Philippines, Singapore, Thailand, and Vietnam. Sources: Asian Bond Online; World Bank, "World Development Indicators." Chart 2 Share of the World's Middle-Income Class 2030 (Projection) 28% 34% 66% 72% Asia Rest of the World Note: The share of the number of people with daily per capita income of between 10 and 100 U.S. dollars in terms of purchasing power parity. Source: Kharas, H. (2010), "The Emerging Middle Class in Developing Countries," OECD Development Centre Working Paper, No. 285. Chart 3 Issuance Activity in East Asia during the Global Financial Crisis % % -20 -100 2006-2007 Domestic Bonds (lhs) International Bonds (rhs) 2008-2009 Percent changes in issuance volume Percent changes in issuance volume 2010-2011 Domestic Syndicated Loans (lhs) International Syndicated Loans (rhs) Note: Percent changes in aggregated total issuance volume of domestic and international bonds, and domestic and international syndicated loans in each subperiod. The figures are calculated by referencing Abraham, F., J. J. Cortina, and S. L. Schmukler (2019), "The Rise of Domestic Capital Markets for Corporate Financing: Lessons from East Asia," World Bank Group Policy Research Working Paper, No. 8844. The top and bottom 10 percentile of the sample has been excluded in the aggregation of data for each sub-period. Source: Dealogic. Chart 4 Interest Rate Benchmark Reform • Raising awareness is the key to success. • In Japan, the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks held the Interest Rate Benchmark Reform Forum on August 1, 2019. http://www.boj.or.jp/en/announcements/release_2019/rel190830f.htm/ Participated widely by: - Financial Institutions - Non-financial Corporates (e.g., TOYOTA) - Institutional Investors (e.g., Insurance Companies) - Relevant Industrial Groups Photo: Shoichi Nose
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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, Shimane, 3 October 2019.
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Yukitoshi Funo: Economic activity, prices, and monetary policy in Japan Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shimane, 3 October 2019. * * * I. Recent Economic and Price Developments A. Overseas Developments I would like to begin by talking about overseas economies, which have been growing moderately on the whole, although slowdowns have continued to be observed. In terms of the outlook, slowdowns are likely to continue for the time being; thereafter, however, overseas economies are expected to grow moderately on the whole with their growth rates rising somewhat. According to the July 2019 World Economic Outlook Update released by the International Monetary Fund (IMF), global growth is forecast at 3.2 percent for 2019 and 3.5 percent for 2020. However, as downside risks concerning the global economy seem to be increasing, careful attention is warranted on the timing and pace of its pick-up. Looking at developments by major region, the U.S. economy has been expanding moderately, although relatively weak developments have been observed in the manufacturing sector. The European economy has remained in its deceleration phase. The Chinese economy has continued to see stable growth on the whole, but weakness has been observed in the manufacturing sector. Other emerging and commodity-exporting economies have maintained their recovery trend as domestic demand has been firm on the whole. As for the outlook, the U.S. economy is expected to maintain its moderate expansion and the European economy is projected to gradually move out of its deceleration phase. The Chinese economy is likely to broadly follow a stable growth path as authorities implement fiscal and monetary policies in a gradual manner. The growth rates of other emerging and commodity-exporting economies are likely to rise on the whole, mainly on the back of the effects of those economies' stimulus measures. Risk factors to the overseas economic outlook are wide ranging and likely to be significant, as exemplified by (1) the U.S. macroeconomic policies and their impact on global financial markets, (2) the consequences of protectionist moves, including those observed in the U.S.-China trade friction, and their effects, (3) developments in emerging and commodity-exporting economies, the progress in global adjustments in IT-related goods, (5) negotiations on the United Kingdom's exit from the European Union (EU) and their effects, and (6) geopolitical risks. In particular, uncertainties regarding the effects of protectionist moves have been heightening. As it can be said that the situation surrounding overseas economies is uncertain, it is necessary to stay vigilant regarding these risk factors, including their impact on the sentiment of firms and households in Japan. B. Japan's Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan. The economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports, production, and business sentiment have been affected by the slowdown in overseas economies. This is evidenced by the real GDP growth rate having registered 1.3 percent for the April-June quarter of 2019 on an annualized quarter-on-quarter basis, representing positive growth for three consecutive quarters. While the contribution of net exports on real GDP growth 1/5 BIS central bankers' speeches has turned negative, that of domestic demand has remained positive. According to the Bank of Japan's September 2019 Tankan (Short-Term Economic Survey of Enterprises in Japan) released at the beginning of October, the diffusion index (DI) for business conditions for all industries and enterprises has remained positive, although the effects of such factors as the slowdown in overseas economies have continued to be observed. With regard to the outlook, Japan's economy is likely to continue on a moderate expanding trend on average, although it is projected to be affected by the slowdown in overseas economies for the time being and due attention needs to be paid to the effects of the October 2019 consumption tax hike on private consumption. In terms of specific figures for the economic growth rate, as provided in the July 2019 Outlook for Economic Activity and Prices (Outlook Report) released by the Bank, the medians of the Policy Board members' forecasts are 0.7 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.1 percent for fiscal 2021. The Bank estimates that the economic growth rate that can be achieved in the long term, or the so-called potential growth rate, is in the range of 0.5-1.0 percent. Thus, Japan's economy is expected to continue growing at a pace consistent with its potential. To elaborate on Japan's economy by demand component, exports are projected to continue showing some weakness for the time being, but thereafter are expected to return to their moderate increasing trend as the growth rates of overseas economies rise. Domestic demand is likely to follow a moderate uptrend. Specifically, business fixed investment is expected to increase moderately amid highly accommodative financial conditions. Private consumption also is likely to continue on a moderate increasing trend as the employment and income situation continues to improve steadily. However, it is necessary to pay close attention to the effects of the consumption tax hike on private consumption. 2. Prices Let me now turn to price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food and that for all items excluding the effects of energy prices are both at around 0.5 percent, together suggesting that the CPI has continued to show relatively weak developments compared to the economic expansion and tight labor market conditions. However, with the economy continuing on an expanding trend, the mechanism for moderate increases in wages and prices driven by a positive output gap has continued to operate. Thus, with regard to the outlook, medium- to long-term inflation expectations are projected to rise gradually as firms' stance is likely to gradually shift toward further raising wages and prices. As a result, the year-on-year rate of change in the CPI (all items less fresh food) is likely to increase gradually over time. In terms of specific figures, the medians of the Policy Board members' forecasts of the year-on-year rate of change presented in the July 2019 Outlook Report are 1.0 percent for fiscal 2019, 1.3 percent for fiscal 2020, and 1.6 percent for fiscal 2021.1 The forecasts assume the following: (1) the consumption tax will be raised to 10 percent in October 2019 and a reduced tax rate will be applied to food and beverages -- excluding alcohol and dining out -- and newspapers, and (2) measures for free early childhood education will be introduced in October 2019, and other measures including free higher education will be introduced in April 2020. II. Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I would like to discuss several points that I think deserve particular attention in examining whether the outlook for economic activity and prices in Japan that I mentioned earlier will be realized. 2/5 BIS central bankers' speeches A. Employment and Income Situation Let me first talk about the employment and income situation. As Japan's economy has continued its moderate expansion, the output gap -- which shows the utilization of labor and capital -- has remained positive. The Labour Force Survey-based number of employees has continued to increase, when smoothing out fluctuations, and the active job openings-to-applicants ratio has been at a high level that exceeds the peak marked during the bubble period. In addition, the unemployment rate has remained at a low level. Amid the tight supply-demand conditions in the labor market, the year-on-year rate of increase in scheduled cash earnings of full-time employees has been in the range of around 0.5-1.0 percent. In addition, that in hourly scheduled cash earnings of part-time employees, which are responsive to supply-demand conditions in the labor market, has registered relatively high growth at around 2 percent. As a result, although total cash earnings per employee have risen moderately, albeit with fluctuations, the increases have remained relatively weak compared to tight labor market conditions, partly due to the high wage elasticity of labor supply in recent years, mainly among women and seniors. As Japan's economy is likely to continue on an expanding trend, it is expected that the supplydemand conditions in the labor market will remain tight. I therefore expect the rate of increase in total cash earnings per employee to gradually accelerate. However, there is a risk that firms will remain cautious with their decisions on wage setting, and in this context, I am paying close attention to developments in their stance regarding wages. B. Prices Next, I will turn to price developments, taking into account the employment and income situation. The year-on-year rate of change in the CPI (all items less fresh food) has remained at around 0.5 percent. The relatively weak price developments compared to the economic expansion and tight labor market conditions are attributed to the mindset and behavior based on the assumption that wages and prices will not increase easily. These mindset and behavior have been deeply entrenched among firms and households, due mainly to the experience of prolonged low growth and deflation. This will not change overnight, and it may in fact take a considerable amount of time. Also, firms have been making efforts to absorb the upward pressure of costs on prices by increasing labor-saving investment and streamlining their business process, and this has allowed firms to maintain their cautious stance toward raising prices. Meanwhile, firms' moves to pass on increases in, for example, personnel expenses and distribution costs, to sales prices have been slowly spreading. Looking at annual price changes across all CPI items less fresh food, the share of price-increasing items minus that of pricedecreasing items recently has been increasing moderately. This is a result of continued price rises in a wide range of items in response to rising personnel expenses and distribution costs. While price developments are affected by a number of factors, I believe the underlying trend in prices is determined by the aggregate supply-demand balance. With the output gap remaining positive, it is projected that wage growth rates and the tolerance of households toward price rises will improve, and that firms' stance will shift toward further raising prices. In this situation, firms' moves to raise prices are likely to become more widespread. The actual rise in wages and prices is then expected to gradually weaken the mindset and behavior based on the assumption that wages and prices will not increase easily. Medium- to long-term inflation expectations are projected to rise gradually as a result. I therefore consider that the momentum toward achieving the price stability target of 2 percent has been maintained. However, attention should be paid to the possibility that such momentum will be lost as downside risks regarding the global economy are significant. 3/5 BIS central bankers' speeches III. Conduct of Monetary Policy Let me now turn to the Bank's monetary policy. The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and has been conducting monetary policy to achieve this target at the earliest possible time, under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control. Under this framework, the Bank has been conducting yield curve control, in which it controls short- and long-term interest rates. Specifically, according to the guideline for market operations, the Bank currently sets the short-term policy interest rate at minus 0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. With a view to lowering risk premia of asset prices, the Bank also purchases assets such as exchange-traded funds (ETFs). I consider that the highly accommodative financial conditions, brought about by powerful monetary easing, have stimulated the spending activities of firms and households, and have contributed significantly to the positive output gap. Given the current situation where prices and inflation expectations have remained sluggish, I think that it is important to sustain the momentum toward achieving the price stability target through maintaining a positive output gap for as long as possible by keeping interest rates at sufficiently low levels for a prolonged time. I also believe that any possible loss in momentum toward achieving the price stability target needs to be preempted. To further clarify the Bank's stance on monetary policy conduct in the current situation where downside risks to economic activity and prices are significant, the Bank stated at the Monetary Policy Meeting (MPM) held in July 2019, that it "will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost." There are various possible measures for additional easing, such as cutting the short-term policy interest rate, lowering the target level of 10-year JGB yields, expanding asset purchases, and accelerating the expansion of the monetary base. Given that, recently, slowdowns in overseas economies have continued to be observed and their downside risks seem to be increasing, it is becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target will be lost. While taking this situation into account, the Bank will reexamine economic and price developments at the next MPM in October. IV. Challenges for Japan's Economy I would now like to express my opinions regarding Japan's current economic situation from a longer-term perspective. According to the Bank's estimates, the potential growth rate has been in the range of 0.5-1.0 percent recently. Although the rate has risen compared to around 2010, it can be said that Japan's growth potential has been sluggish of late. This is also an indication of the various challenges that Japan faces in achieving a rise in productivity. For example, it is difficult in Japan to establish business models through which firms can benefit from economies of scale, and where cost efficiency improves along with an expansion of business size. Although Japan's economy is the world's third largest, it is far smaller than that of the United States or China, and smaller also than that of the EU taken as a whole. Let me note that the rise of Chinese firms is backed by a rapid expansion of the Chinese economy. I think that the sluggish improvement in productivity among Japanese firms in recent years is partly attributable to the economic situation in Japan that I just outlined. Cross-border mergers and acquisitions undertaken by Japanese firms recently can be considered as one of the initiatives addressing the challenges. However, managing foreign firms is a new experience for many Japanese firms, and is likely to be quite difficult as there are a number of issues to be tackled, such as securing managers and adapting to different corporate 4/5 BIS central bankers' speeches cultures. Recent protectionist moves could also become an obstacle to the free mobility of labor, goods, money, and information. Since Japan's domestic market is small, I think that the business environment is becoming increasingly severe for Japanese firms. Despite these trends, I see the potential growth rate rising through improvements in productivity as a wide range of entities continue to introduce structural reforms and implement growth strategies. With the output gap remaining positive, firms have continued to undertake laborsaving investment, mainly through the use of information technology. Furthermore, they have proceeded with working-style reforms and other initiatives that reflect demographic changes and the considerably tight labor market conditions. Steady progress has also been made in achieving diversity in the labor force, through the hiring of women, seniors, and foreign workers. As managers and workers have become aware of the need for greater efficiency and productivity, an increasing number of firms have been working to this end, not only in manufacturing, but also mainly in the administrative field, where robotic process automation (RPA) has been introduced. There is still significant room for improvement, mainly in the use of human resources and the enhancement of business efficiency, and I think we can expect a further rise in productivity through such initiatives. Although these structural reforms and growth strategies may exert downward pressure on wages in the short term, I believe that they will play a role in underpinning the virtuous cycle from income to spending in the long term. Specifically, rising productivity will act as the starting point of such a cycle, stimulating price rises through increased wages and private consumption. Let me note, however, that raising productivity and growth potential does not occur overnight. It is therefore important to ensure a sustained virtuous cycle, in which increased demand encourages progress in various initiatives, as the Bank's monetary policy stimulates aggregate demand and reasonably tight supply-demand conditions are maintained. Thus, to achieve its price stability target and realize sustainable economic growth in a coordinated manner, the Bank should persistently continue with its powerful monetary easing and firmly support the initiatives of a wide range of entities. 5/5 BIS central bankers' speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2019 Global Meeting of the Emerging Markets Forum, Leesburg, Virginia (USA), 20 October 2019.
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October 20, 2019 Bank of 日 Japan For Sustainable Development of Emerging Economies Speech at the 2019 Global Meeting of the Emerging Markets Forum Haruhiko Kuroda Governor of the Bank of Japan I. Introduction It is my great pleasure to have the opportunity to give a speech at the Emerging Markets Forum today. The situation surrounding emerging economies has been changing rapidly. The global economy has recently been slowing down and there are various downside risks, ranging from trade tensions to geopolitical risks. At this difficult point in time, it is critically important for the global economy that emerging economies achieve sustainable growth. As you well know, after the global financial crisis, the growth of emerging economies contributed significantly to the recovery of the world economy. Over 70 percent of the recovery in the global economy since 2009 is due to the contribution of emerging economies. It would not be too much to say that the performance of emerging economies is key to the global economy. From the medium- to long-term perspective, there have been constant structural changes, including further globalization, advances in digital technologies, and climate change. For emerging economies to achieve sustainable growth, it is essential to have a long-term vision for the economy and society, and to navigate the transition process successfully. Making use of the fruits of the G20 meetings under Japan's presidency this year, I would like to take up three topics today that are particularly important to the medium- to long-term development of emerging economies. Namely, promoting financial inclusion, achieving sustainable growth, and addressing the prospective aging of the population. II. Issues for the Medium- to Long-Term Development of Emerging Economies A. Promoting Financial Inclusion The first topic I would like to consider is the promotion of financial inclusion. Although the definition of financial inclusion varies, it is commonly taken to mean that "households and businesses have access to appropriate financial services and are able to use them effectively." In emerging countries, a significant portion of the population does not have enough access to financial services, especially people on low incomes and those who live in remote islands and mountainous regions. According to a report by the World Bank, about 40 percent of the adult population in emerging countries does not have a bank account.1 For those people to obtain access to appropriate financial services would accelerate the reduction of poverty and inequality. Enhancing financial inclusion would not only help alleviate poverty and inequality, it also has huge potential in promoting economic growth. Many researchers and policy makers argue that financial inclusion would boost economic growth.2 For example, borrowing from financial institutions allows a firm to invest more in R&D and capacity expansion than would be possible using only its cash reserves. Housing loans and credit cards enable households to consume and invest more than the amount of cash at hand. Savings in a bank account generate interest income. Access to financial services such as these leads to more efficient business development and active consumption, thereby promoting overall economic growth of the country. Financial inclusion would also enhance the effectiveness of monetary and fiscal policy. Regarding monetary policy, as most of the interest rates of borrowings and savings by firms and individuals are based on policy rates, central banks can affect their behavior by changing policy rates. This would improve the effectiveness of monetary policy and help smooth the economic cycle in the long run. Enhanced access to financial services would also increase the effectiveness of fiscal policy. For example, ensuring a means to transfer money to every individual would allow policy makers to design subsidization programs that are targeted at a specific segment of society. This would make possible a finer-tuned redistribution policy. In addition, tax collection would become more effective. In advancing financial inclusion, it is necessary to develop both "hard" and "soft" infrastructures. Hard infrastructures typically include telecommunications, such as the internet and mobile phones. Soft infrastructure includes for example the active use of Fintech, which, in addition to improving financial literacy, would be effective in broadening the range of financial services available. In the short run, the introduction of state-of-the-art Asli Demirgüç-Kunt et al., "The Global Findex Database 2017: Measuring Financial Inclusion and Fintech Revolution," World Bank Group (2018). 2 For example, see: Thorsten Beck, Asli Demirgüç-Kunt, and Ross Levine, "Finance, Inequality and the Poor," Journal of Economic Growth, Vol. 12 (1), pp. 27-49 (2007). Fintech might lead to so-called leapfrogging. This refers to the phenomenon where the convenience of services is drastically enhanced by taking advantage of new technologies even before services based on older technologies have become entrenched. For example, mobile payments spread rapidly in China in just a few years. Providing payment services via mobile phone does not require conventional physical infrastructure such as branch and ATM networks that were considered indispensable in providing broad access to financial services. China not only enjoys improved access to banking services but has also saved on the cost of building the physical infrastructure required for traditional banking. That said, it should be noted that these benefits come with new risks. For example, large-scale system problems and cyber-attacks can negatively affect corporate management and the daily lives of individuals. Privacy protection is important, and we should be mindful that these new technologies might be used for money laundering and tax evasion. Moreover, policy makers should consider carefully the possible impact of the broader use of digital technologies on financial stability and the effectiveness of monetary policy. Authorities should endeavor to maximize the benefits of new technologies while appropriately addressing the accompanying risks, through close cooperation, both domestically and internationally. B. Achieving Sustainable Growth The second topic is the achievement of sustainable growth. Since the industrial revolution, the global economy has undergone remarkable development. At the same time, however, a number of issues have emerged that require international cooperation to solve, such as those related to poverty, inequality and the environment. In 2015, the United Nations adopted the Sustainable Development Goals (SDGs), a set of goals to be achieved by 2030 targeting poverty, the environment, and other issues. Here, I would like to provide two observations on social and environmental issues in relation to achieving sustainable growth. First, the enormous effort and cost involved in dealing with social and environmental issues is justified by the expected returns. In other words, there is no trade-off between solving social and environmental issues and achieving economic growth. Rather, they are complementary to each other. For example, significant progress has recently been made in reducing poverty. According to the World Bank, in 1981, more than 40 percent of the world's population was living in extreme poverty, but the figure has fallen to around 10 percent in 2019.3 While economic growth leads to a decline in the poverty rate, the reduction of poverty and the resulting inclusive growth will in turn enhance economic growth, leading to a further reduction in poverty. The relationship between economic development and poverty reduction can be regarded as mutually-reinforcing. Consensus has not yet been reached on the causal relationship between income disparity and growth rate in economies with a low poverty rate, as much theoretical and empirical research shows differing results.4 That said, I believe an increase in the number of people who are given the opportunity for higher education and to learn advanced skills would lead to an accumulation of human capital, positively affecting economic growth from the supply side. With the digitalization of the economy, human capital becomes more important as the industrial structure changes over time, shifting from labor-intensive to capital-intensive, and eventually to knowledge-intensive. Moreover, the promotion of financial inclusion, which I mentioned earlier, and a more stable political and social situation through the reduction of inequality would surely have a positive impact on economic growth by attracting business investment, and through stabilizing macroeconomic conditions more generally. Environmental problems are, needless to say, a common threat to both advanced and emerging countries. Climate change has already affected emerging economies through the increase in extreme weather events and natural disasters such as storms, floods, and drought. According to an estimate by the United Nations, the world population is expected to World Bank Group, "September 2019 PovcalNet Update." Some researchers argue that it is not inequality of income, but inequality of opportunity that matters for economic growth. For details, see: Shekhar Aiyar and Christian Ebeke, "Inequality of Opportunity, Inequality of Income and Economic Growth." IMF Working Paper No. 19/34, International Monetary Fund (2019). increase by 2 billion in 30 years, reaching 9.7 billion by 2050. Based on this estimate, poor harvests and water shortages caused by climate change would become even more serious.5 The effects of climate change have been studied from a variety of perspectives. For example, there is a wealth of research on the relationship between temperature and labor productivity. One study shows that an increase in temperature of 1 degree Celsius from 25 degrees reduces work performance by 2 percent.6 Does this tally with your own experience? There is also a large body of research concerning the effects of climate change on energy demand, public health, and social stability, among other things.7 My point is that there is a strong link between resolving social and environmental issues and macroeconomic growth, and we should tackle these challenges in a proactive manner, not only to meet the demands of society but also to enhance medium- to long-term economic growth. The second observation is that we should use the markets and incentive mechanisms to pursue sustainable growth. For example, when making investment decisions, investors have increasingly been taking into account environmental, social, and governance (ESG) criteria, alongside purely financial factors. This trend has been triggered in part by the Principles for Responsible Investment initiative supported by the United Nations. This initiative calls for investors to consider ESG factors in investment decisions while fulfilling their fiduciary responsibilities. Although the main target of ESG investing was initially equities, it has been expanding to include also bonds and loans. In Europe and China especially, there has been a dramatic increase in the issuance of so-called green bonds, to finance projects aimed at addressing environmental problems. These moves are expected to lead to environment-related innovation in such areas as the use of renewable energy. United Nations, "World Population Prospects: 2019 Revision." Olli Seppänen, William J. Fisk, and David Faulkner, "Cost Benefit Analysis of the Night-Time Ventilative Cooling in Office Building." (2003), https://escholarship.org/content/qt3j82f642/qt3j82f642.pdf?t=li4xtt 7 Melissa Dell, Benjamin F. Jones, and Benjamin A. Olken, "What Do We Learn from the Weather? The New Climate-Economy Literature." Journal of Economic Literature 52 (3), 740-798 (2014). Of course, appropriate institutional arrangements and guidance by the authorities are essential to maximize the potential of the markets and incentive mechanisms to address these issues. For example, governments and public institutions should continue to engage actively in long-term and large-scale infrastructure investment, as well as in establishing the regulatory systems necessary to deal with environmental issues. Initiatives to ensure the smooth functioning of market mechanisms are also important, including establishing frameworks for the standardization of ESG investments. Of course there are many issues which cannot be dealt with solely by market mechanisms, including international assistance for very low-income countries and direct support for those who are left behind in developing countries. C. Addressing the Prospective Population Aging The third topic is the prospective aging of the population. "Aging and its policy implications" has been adopted as one of the G20 priorities under Japan's presidency. You may perhaps think that aging is not an imminent policy issue in your country. In many emerging countries, the working age population is expected to grow for a while. However, once the birthrate declines and the size of the working age population begins to decrease, the shape of the demographic pyramid could change drastically within a timeframe of perhaps 20 to 30 years. Let us take Japan's case as an example. In 1970, about 10 workers supported one elderly person. The figure had decreased to 4 workers in 2000, and 2.3 workers in 2015. The decrease in birthrate and the aging of the population occurs over a shorter period and at a faster pace than you might expect.8 The good news about demographic change is that we can forecast prospective changes well in advance and with a certain degree of accuracy. In addition, emerging countries can learn from the precedents set in those advanced countries that are already experiencing problems related to an aging population. It is not too early to start preparing for prospective aging. Although population aging has a wide range of economic implications, I would like to focus today on one of the main issues associated with aging, the pension system, by reviewing National Institute of Population and Social Security Research, "Population Projections for Japan." Japan's experience. The pension system is at the core of the social security system. As the pension system has a significant impact on people's lives, careful and detailed consideration is necessary before implementing reforms. For over 20 years in Japan, we have been discussing various issues, including how to secure the financial resources necessary to support the pension system, and have made steady progress with reforms. The Japanese pension system is largely based on the so-called pay-as-you-go scheme, where benefits for the elderly are paid out of premiums collected from the contemporary working age population. Therefore, the aging of the population demands a regular review of the balance between premiums, benefits and government subsidies. After long and intensive discussion, a number of reforms have been adopted, including a raise in the pension age and an increase in the subsidy from the government. A mechanism called the "macroeconomic slide" has also been introduced, which automatically adjusts the amount of pension benefit by taking into account changes in the number of people insured and average life expectancy. At least once every five years, the government must carry out a comprehensive review of the financial conditions of the pension system, including its long-term prospects. The aging of the population has huge implications not only for the pension system but also for public finances in general. Expenditure on health and elderly care has increased significantly in Japan. The proportion of social security expenses to total annual expenditure has soared from around 14 percent in 1970 to around 35 percent at present. Maintaining the credibility of public finance by ensuring medium- to long-term fiscal sustainability is essential. To this end, planning and reviewing the social security and tax system so that they can adapt to demographic changes is critically important. Maintaining economic vitality amid an aging and shrinking population is also a critical issue. From a macroeconomic perspective, labor participation and labor productivity need to be increased. Labor participation of the elderly and women has risen significantly in Japan over the past several years, helping to support economic growth. Japanese society has come to accept a greater diversity of work styles, better suited to individual circumstances, particularly for families with small children. Faced with serious labor shortages, firms have been making labor-saving investments, using information and communication technologies and artificial intelligence to offset the shortfall in labor. In terms of industrial structure, the aging of society can induce the growth of new industries, creating jobs and spurring innovation. Medical, health, and nursing care are prime examples. As aging is a global trend, industries providing elderly care services and support have a good opportunity for rapid growth. Policy makers also have an important role to play in facilitating adaptation to the changing business environment. Lastly, I would like to emphasize that the aging of the population itself is by no means a negative thing. The proportion of the elderly to the total population is around 30 percent in Japan at present.9 With improvements in living conditions and the progress of medical technology, the number of healthy and active elderly has been steadily increasing. Let me give you an example of an elderly person who made a significant contribution to the world. The Italian Renaissance sculptor, Michelangelo, worked as chief architect in the refurbishment of Saint Peter's Basilica when he was 74 years old, coincidentally, the same age as I am at present. Aging can enrich our lives, and social systems should be designed so that the richness of aging can be enjoyed to its fullest. III. Concluding Remarks I have talked today about the issues to be addressed for sustainable growth in emerging economies. As the issues are wide-ranging, it is no easy task to deal appropriately with all of them. However, emerging countries do have a so-called latecomers' advantage in being able to benefit from the leapfrogging I mentioned earlier. By making use of advanced digital technologies, emerging countries can skip investment in the infrastructures that have already become obsolete in advanced economies. And when it comes to population aging, they can learn from the experience and mistakes of advanced economies. I believe that emerging economies will make steady progress in overcoming difficulties and will be able to achieve sustainable and balanced development. Thank you for your kind attention. Ministry of Internal Affairs and Communications, "Demographics of Japan."
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 5 November 2019.
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November 5, 2019 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 a distinguished gathering of business leaders in the Chubu region. I would like to take this chance to express my sincerest gratitude for your cooperation with various activities of the Bank of Japan's Nagoya Branch. At the Monetary Policy Meeting (MPM) held last week, the Bank updated its projections for Japan's economic activity and prices through fiscal 2021. In particular, it examined economic and price developments while paying closer attention to the fact that slowdowns in overseas economies have continued and their downside risks seem to be increasing. Today, while outlining this examination, I would like to explain the Bank's view on Japan's economic activity and prices as well as its thinking behind the recent conduct of monetary policy. I. Economic Developments Let me start by talking about economic developments. At the MPM held last week, the Bank assessed that Japan's economy was likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021. There has been no change to this overall assessment. While the recovery in external demand is expected to slow due to the delay in the timing of a pick-up in overseas economies, domestic demand is likely to be firm as the impact of the delay is expected to be limited. I will elaborate on this mechanism in what follows. First, I would like to explain developments in overseas economies (Chart 1). Since the turn of this year, the diffusion indexes (DIs) for business sentiment of manufacturing firms on a global basis have remained below 50, which is the borderline between improvement and deterioration of business conditions perceived by firms. The U.S.-China trade friction has exerted a negative impact on the global trade activity as there had been incremental rises in additional tariffs until a partial agreement was reached in mid-October. In addition, slowdowns have continued to be observed in emerging economies, partly because it has been taking time for the effects of China's economic policy to materialize. Against the background of these developments, a pick-up in overseas economies has been delayed and its timing is expected to lag behind by about half a year compared to the previous projection. The World Economic Outlook (WEO) released by the International Monetary Fund (IMF), which has been revised somewhat downward from the July projections, presents a similar view. However, the Bank's projection for overseas economies does not assume further deceleration. The IMF also maintains the outlook that the global economy will accelerate its growth pace next year. The reason is as follows. Since the turn of this year, monetary easing has been pursued by the Federal Reserve and the European Central Bank (ECB), in addition to central banks in many emerging economies. While the household and nonmanufacturing sectors have been steady thus far despite the weak manufacturing sector, accommodative financial conditions are expected to support domestic demand in these economies. In addition, there has been gradual progress in adjustments in IT-related goods, which had been one of the factors behind the weakness in the global manufacturing sector (Chart 2). The world semiconductor shipments had continued to register negative growth on a quarterly basis, but have been flat recently. Thus, downward pressure stemming from adjustments in IT-related goods is expected to diminish. Under these circumstances, overseas economies are expected to raise their growth rates and grow moderately on the whole. However, this outlook is based on the assumption that the trade friction will not intensify further. As I will explain later, there is no change in the situation that downside risks concerning overseas economies warrant vigilance. Although the timing of a pick-up in overseas economies has been delayed, the Bank expects that Japan's economy will not decelerate substantially, as I mentioned earlier. This is because, while external demand is expected to decrease, reflecting developments in overseas economies, domestic demand is likely to remain firm. Japan's economy has experienced many business cycle episodes where the initial drivers were fluctuations in external demand. However, in the current phase, weakness in external demand has not affected domestic demand, at least thus far, mainly due to steady business fixed investment. In addition, the Bank had paid careful attention to the impact of the consumption tax hike in October based on past experience, and this has remained small compared to that of the previous tax hike in 2014 as far as available data suggest. In the next part of my speech, I will elaborate on developments in economic activity in Japan in terms of external demand and domestic demand. First, external demand has continued to show some weakness, mainly in capital goods, as signs of a further deceleration in business fixed investment have been observed, such as in China (Chart 3). Business sentiment in the manufacturing sector in the September Tankan (Short-Term Economic Survey of Enterprises in Japan) has become clearly cautious, reflecting weakness in external demand and related production. As for the outlook, external demand is likely to continue to show some weakness for the time being due to the delay in the timing of a pick-up in overseas economies. On the other hand, domestic demand has remained firm. In the September Tankan, business sentiment of the nonmanufacturing sector has maintained a relatively high level. Among components of domestic demand, business fixed investment has continued on an uptrend (Chart 4). Business fixed investment plans in the September Tankan were steady, exceeding the average of past September surveys. Specifically, while machinery investment has been somewhat weak in the manufacturing sector due to the effects of the slowdown in overseas economies, it has remained steady in the nonmanufacturing sector. In the nonmanufacturing sector, not only machinery investment but also software investment has seen an acceleration in its growth pace, reflecting strong demand for saving labor and improving efficiency. Research and development (R&D) investment has maintained its pace of increase in a wide range of industries, including those related to exports. Construction investment also has continued on an uptrend, mainly on the back of urban development projects and the construction of logistics facilities accompanying the spread of e-commerce. With regard to the outlook, business fixed investment is projected to see a temporary deceleration in its pace of increase, mainly in the manufacturing sector, reflecting the effects of the slowdown in overseas economies. However, amid accommodative financial conditions, it is expected to continue increasing moderately thereafter, mainly for investments that are relatively less susceptible to the effects of changes in overseas demand, such as investment for urban development projects, labor-saving investment, and R&D investment for growth areas. Such steady business fixed investment seems to be attributable to changes in firms' behavior, which has become positive in terms of taking future business opportunities and addressing long-term challenges because the moderate expanding trend in Japan's economy has continued for a few years and a sustained decline in prices is no longer observed. Private consumption has increased moderately (Chart 5). The impact of the consumption tax hike is likely to be smaller than that of the previous tax hike in 2014, mainly because the net burden on households is small and various measures to smooth out demand have been implemented. The moderate increase in private consumption is mainly attributable to the improvement in the employment and income situation (Chart 6). Labor market conditions have been tight, in a situation where the active job openings-to-applicants ratio has stayed at a level that exceeds the peak marked during the bubble period and the unemployment rate has declined to the range of 2.0-2.5 percent. Employee income has continued to increase. Regarding the outlook, with the employment and income situation continuing to improve, private consumption is expected to follow a moderate increasing trend, although it is likely to be pushed down temporarily due to the effects of the tax hike. Meanwhile, government spending is likely to underpin economic activity going forward, mainly on the back of an increase in disaster-related restoration and reconstruction, Olympic Games-related expenditure, and public investment associated with national resilience. Thus, Japan's economy is likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021 -- as the impact of the slowdown in overseas economies on domestic demand is expected to be limited, although the economy is likely to continue to be affected by the slowdown for the time being (Chart 7). In the latest Outlook for Economic Activity and Prices (Outlook Report), the medians of the forecasts for the growth rate are 0.6 percent for fiscal 2019, 0.7 percent for fiscal 2020, and 1.0 percent for fiscal 2021. So far, I have talked about the outlook for economic activity. There is no change in the situation that downside risks are significant, mainly regarding developments in overseas economies. As for the U.S.-China trade friction, although the partial agreement reached last month can be viewed as a positive move, future developments remain uncertain. With regard to the United Kingdom's exit from the European Union (EU), a situation where the United Kingdom leaves the EU without a deal at end-October was avoided, but there remain uncertainties given that the general election is scheduled to take place in December. There also are uncertainties such as over developments in emerging economies and geopolitical risks. Moreover, attention should be paid to the fact that global financial markets have become more reactive to these risks. If such downside risks materialize, positive behavior by firms could become cautious. Besides risks concerning overseas economies, the impact of the consumption tax hike continues to warrant attention. As I have explained, although the degree appears to be small for now, the Bank will continue to conduct a careful examination of the impact, including that on consumer sentiment. II. Price Developments Let me move on to price developments. At the September MPM, the Bank judged that it was becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target of 2 percent would be lost, given that slowdowns in overseas economies had continued to be observed and that their downside risks seemed to be increasing. Taking this situation into account, it examined price developments and assessed the momentum toward achieving the price stability target at last week's MPM. In assessing the momentum, the Bank considers it particularly important to examine developments in (1) the output gap, which indicates the strength of economic activity, and (2) inflation expectations, which show people's perception of prices. First, I would like to explain developments in the output gap (Chart 8). The output gap is expected to narrow temporarily within positive territory, but remain at around the current level on average. In other words, aggregate demand is likely to continue exceeding average supply capacity. As I explained earlier, Japan's economy is expected to grow temporarily at a somewhat slower pace than its potential, reflecting the effects of the slowdown in overseas economies and the consumption tax hike, and the positive output gap is projected to narrow. However, throughout the projection period, domestic demand is likely to continue on an uptrend as the impact of the slowdown in overseas economies is expected to remain limited. In addition, since overseas economies are expected to pick up eventually, Japan's economy is likely to maintain an expanding trend. Under these circumstances, the output gap is expected to remain at around the current positive level on average. Next, let me talk about developments in inflation expectations (Chart 9). Measures of inflation expectations based on surveys, for example, have shown somewhat mixed signals, in that some have indicated relatively weak developments while others have shown an increase; on the whole, however, inflation expectations have been more or less unchanged. In order to grasp developments in people's inflation expectations, it also is important to monitor changes in households' perception of prices as well as firms' price-setting stance. When "comments on the rise in prices" from the Opinion Survey on the General Public's Views and Behavior are regarded as a measure for households' tolerance of price rises, households' tolerance since 2017 has remained at a level that exceeds the past average. As for the price-setting stance of firms that are closely related to consumption, the output prices DI for consumption-related industries shows that the proportion of enterprises answering that output prices have risen has continued to exceed the proportion of those answering that such prices have fallen, and the gap has been expanding, albeit at a moderate pace. Regarding the outlook, it is expected that households' tolerance of price rises will increase steadily and firms' stance gradually will shift toward further raising prices as the employment and income situation is likely to continue improving with the output gap remaining positive. Accordingly, households' and firms' inflation expectations are likely to increase gradually. Moreover, developments in crude oil prices and global financial markets affect prices. Crude oil prices have been more or less flat -- albeit with fluctuations -- since around this summer, although they have been lower compared to the level seen around spring. In global financial markets, investors' risk aversion had continued to be observed, but the markets recently have been calm compared to a while ago. Given these observations, the Bank judged at last week's MPM that there had been no further increase in the possibility that the momentum toward achieving the price stability target would be lost. On this basis, it expects that the year-on-year rate of change in the consumer price index (CPI) is likely to increase gradually toward 2 percent, mainly on the back of the output gap remaining positive and inflation expectations rising, despite the CPI inflation rate being affected by such factors as the decline in crude oil prices for the time being (Chart 10). In the latest Outlook Report, it is projected that the year-on-year rates of change in the CPI excluding fresh food will be 0.7 percent for fiscal 2019, 1.1 percent for fiscal 2020, and 1.5 percent for fiscal 2021. That said, risks to the outlook for prices are skewed to the downside, and thus close attention should continue to be paid to the possibility that the momentum toward achieving the price stability target will be lost. In particular, it is necessary to take into account the possibility that, if downside risks to economic activity materialize, they will affect prices, mainly through downward pressure on the output gap. Therefore, the Bank will continue to carefully examine economic and price developments and closely monitor whether there will be no increase in the possibility that the momentum toward achieving the price stability target will be lost. III. The Bank's Conduct of Monetary Policy Now, I would like to talk about the Bank's conduct of monetary policy. The Bank has been conducting monetary policy while examining economic and price developments from two perspectives: the baseline scenario for the outlook and risk analysis. In the current situation where downside risks to economic activity and prices are significant, the examination of risks is becoming increasingly important (Chart 11). In order to make this thinking clearer, the Bank clarified in the July policy statement that it would not hesitate to take additional easing measures if there was a greater possibility that the momentum toward achieving the price stability target would be lost, and emphasized in the September statement that it would reexamine economic and price developments at the October MPM, when it releases the Outlook Report. At the same time, in a situation where downside risks to economic activity and prices have become significant, the aim of these descriptions in the statements was to indicate that the Bank's basic policy stance is further tilted toward monetary accommodation. At last week's MPM, based on our examination results, the Bank judged that there had been no further increase in the possibility that the momentum toward achieving the price stability target would be lost, but that it was necessary to continue paying close attention to the possibility, given that downside risks concerning overseas economies seemed to be increasing. With a view to clarifying the assessment of economic and price developments as well as the Bank's policy stance of being further tilted toward monetary accommodation, the Bank decided on a new forward guidance for the policy rates at that meeting (Chart 12). Specifically, the Bank expects short- and long-term policy interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. There are two points here. First, the Bank clearly related the forward guidance to the momentum toward achieving the price stability target. Second, the Bank reflected its policy stance of being tilted toward monetary accommodation in the forward guidance for the policy rates as well. On this basis, it clarified that there would be a downward bias in the policy rates. However, I would like to add that this does not limit additional easing measures to lowering the policy rates. There is no change in our understanding that, besides lowering the policy rates, there are various possible measures for additional easing -- such as expanding asset purchases and accelerating the expansion of the monetary base -- depending on developments in economic activity and prices as well as financial conditions, and that combinations or applications of these various measures also would be an option. The Bank will continue to conduct appropriate monetary policy without preconception, taking account of developments in economic activity and prices as well as financial conditions, while carefully examining various risks. Conclusion Before concluding my speech, I would like to touch on developments in the economy of the Tokai region. Since the turn of the year, the regional economy has remained steady despite the slowdown in overseas economies affecting exports and production across Japan. Labor market conditions in the region have remained tight; for more than a year, the active job openings-to-applicants ratio has been around 2 times and the unemployment rate has been 2 percent or below. In addition, growth in scheduled cash earnings has exceeded that for Japan as a whole. As for the corporate sector, business fixed investment has continued to increase on the back of high levels of corporate profits. With the slowdown in overseas economies continuing, there have been some postponements in nonessential and nonurgent investment intended for capacity expansion, but forward-looking investments -- that is, R&D investment as well as labor-saving and efficiency-improving investment -- have increased. Such forward-looking investments that are relatively less susceptible to changes in overseas demand are underpinning the expanding trend in the economic activity across the country, and this tendency is notable particularly in this region. The steady regional economy seems to be attributable not only to the high quality of manufacturing but also the high ability to analyze and grasp consumers' needs in detail. For example, in the automobile industry, a framework has been established in which firms monitor developments in demand worldwide through detailed analysis and provide instantaneous feedback on the outcome to their production process. Through such framework, they can completely manage the process in an integrated manner, starting from market analysis through the distribution of products to their customers, which enables them to run their business flexibly amid high uncertainties. I would like to close my speech today by making a commitment that the Bank will persistently pursue powerful monetary easing, thereby providing its utmost support for your corporate activities. Thank you very much for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagoya November 5, 2019 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Economic Developments Global Economy Global Manufacturing PMI Global Growth Rate (IMF Projections) s.a., DI. Global economy Advanced economies Emerging and commodity-exporting economies 6.0 y/y % chg. 5.5 5.0 2020: +3.4% 4.5 2018: +3.6% 4.0 3.5 3.0 2.5 1.5 2019: +3.0% Average from 1980 through 2018: +3.5% 2.0 Projections 1.0 0.5 0.0 CY12 -0.5 CY 00 Notes: 1. In the left chart, figures for the global economy are the "J.P. Morgan Global Manufacturing PMI." Figures for advanced economies as well as emerging and commodityexporting economies are calculated as the weighted averages of the Manufacturing PMI using GDP shares of 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, such as China, South Korea, Taiwan, Russia, and Brazil. Notes: 2. In the right chart, figures for 2019 and 2020 are the IMF's projections as of October 2019. Sources: IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.); IMF, etc. Chart 2 I. Economic Developments World Semiconductor Shipments s.a., q/q % chg. -5 -10 -15 -20 -25 CY 00 Note: Figures are based on staff estimates using WSTS data. Chart 3 I. Economic Developments Exports, Production, and Business Sentiment Exports and Production Business Conditions DI (Tankan) 115 s.a., 2012/Q1=100 DI ("favorable" - "unfavorable"), % points Real exports Manufacturing Nonmanufacturing Production -5 -10 -15 CY 12 -20 CY 12 Sources: Ministry of Finance; Ministry of Economy, Trade and Industry; Bank of Japan. Chart 4 I. Economic Developments Business Fixed Investment Business Fixed Investment Plans (Tankan) y/y % chg. Software Investment (Tankan) FY 2005=100 All industries Construction Retailing Accommodations, eating & drinking services FY 2019 FY 2018 FY 05 average (FY 2004-2018) y/y % chg. R&D Expenditure Manufacturing Transport equipment Chemicals -2 Mar. June Sept. Dec. Forecast Actual -5 FY12 Notes: 1. In the left chart, figures are for all industries including financial institutions. Figures include software and R&D investment and exclude land purchasing expenses. Notes: 2. In the upper right chart, figures through fiscal 2018 are actual results. Figures for fiscal 2019 are forecasts from the September 2019 survey. Notes: 3. In the lower right chart, figures are those of firms with capital of 1 billion yen or more on a consolidated basis. Figures for fiscal 2019 are based on staff calculations using figures adjusted for the average of changes from planned to actual expenditure in fiscal 2012-2018. Sources: Development Bank of Japan; Bank of Japan. Chart 5 I. Economic Developments Private Consumption s.a., CY 2011=100 Consumption Activity Index (travel balance adjusted, real) CY 12 Note: Figures exclude inbound tourism consumption and include outbound tourism consumption. Sources: Bank of Japan, etc. Chart 6 I. Economic Developments Employment and Income Situation Active Job Openings-to-Applicants Ratio and Unemployment Rate 7 s.a., % Unemployment rate (left scale) Employee Income s.a., ratio 1.8 1.6 Active job openings-to-applicants ratio (right scale) 1.4 y/y % chg. 1.2 -2 1.0 Total cash earnings -4 Number of employees 0.8 0.6 CY 04 0.4 Employee income -6 -8 Note: In the right chart, Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Employee income = total cash earnings ("Monthly Labour Survey") × number of employees ("Labour Force Survey"). Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 7 I. Economic Developments BOJ's Economic Forecasts Real GDP <October 2019 Outlook Report> s.a., ann., tril. yen Fiscal 2021 +1.0% Fiscal 2020 +0.7% Fiscal 2019 +0.6% FY 12 Note: Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Cabinet Office; Bank of Japan. Chart 8 II. Price Developments Consumer Prices and Output Gap % y/y % chg. Output gap (left scale) CPI (less fresh food and energy, right scale) -2 -1 -4 -2 -6 -3 -8 CY 85 -4 Note: Figures for the CPI are adjusted for changes in the consumption tax rate. Figures for the output gap are based on BOJ staff estimates. Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 9 II. Price Developments Inflation Expectations 2.5 Synthesized Inflation Expectations Indicators (Survey Data etc.) y/y % chg. 2.0 Households' Tolerance of Price Rises Firms, households, and experts (QUICK Survey) Firms, households, and experts (Consensus Forecasts) Firms, households, and experts (inflation swap rate) 1.5 1.0 -5 0.5 -10 0.0 CY 07 -15 CY 83 Estimates of Inflation Expectations (Economic Models) 2.0 y/y % chg. Output Prices DI for Consumption-Related Industries (Tankan) DI ("rise" - "fall"), % points Firms' forecasts 1.5 1.0 Long-term 1 Long-term 2 Medium-term 0.5 0.0 -0.5 CY 07 DI ("favorable" - "unfavorable"), % points -10 Large enterprises Small enterprises -20 -30 -40 CY07 Note: For details, see BOX 7 in the October 2019 Outlook Report. Sources: QUICK, "QUICK Monthly Market Survey (Bonds)," "QUICK Tankan"; JCER, "ESP Forecast"; Consensus Economics Inc., "Consensus Forecasts"; Wolters Kluwer, "Blue Chip Economic Indicators"; Bloomberg; Ministry of Finance; Ministry of Internal Affairs and Communications; Cabinet Office; Bank of Japan. Chart 10 II. Price Developments BOJ's Price Forecasts CPI (All Items Less Fresh Food) <October 2019 Outlook Report> 2.5 y/y % chg. Price Stability Target (2%) 2.0 Fiscal 2019 +0.7% 1.5 1.0 Fiscal 2021 +1.5% 0.5 Fiscal 2020 +1.1% 0.0 -0.5 -1.0 FY12 Note: The actual figures exclude the direct effects of the consumption tax hike in April 2014. Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 11 III. The Bank's Conduct of Monetary Policy BOJ's Conduct of Monetary Policy Assessment of Economic Activity and Prices from Two Perspectives The first perspective Examining the outlook for economic activity and prices deemed most likely by the Bank of Japan The second perspective Examining, in a longer term, various risks that are most relevant to the conduct of monetary policy Excerpt from September 2019 Statement on Monetary Policy The Bank will continue with "Quantitative and Qualitative Monetary Easing (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. . . . In particular, in a situation where downside risks to economic activity and prices, mainly regarding developments in overseas economies, are significant, the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. Given that, recently, slowdowns in overseas economies have continued to be observed and their downside risks seem to be increasing, the Bank judges that it is becoming necessary to pay closer attention to the possibility that the momentum toward achieving the price stability target will be lost. Taking this situation into account, the Bank will reexamine economic and price developments at the next MPM, when it updates the outlook for economic activity and prices. III. The Bank's Conduct of Monetary Policy Chart 12 BOJ's Forward Guidance BOJ decided on a new forward guidance for the policy rates (Oct. 2019) As for the policy rates, the Bank expects short- and long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. First point: Clearly related to the momentum toward achieving the price stability target. Second point: Clarified that there was "a downward bias" in the policy rates.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the PBC School of Finance, Tsinghua University, Beijing, 7 November 2019.
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November 7, 2019 Bank of Japan Japan's Experience and Its Implications for China -- Monetary Policy and Financial System -Speech at the PBC School of Finance, Tsinghua University Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction Good afternoon everyone. It is a great honor to have this opportunity to speak to you today at the esteemed Tsinghua University. China and Japan are only separated by a narrow body of water. This nearness has historically enabled us to interact actively, and our two countries have been learning from each other for a long time. However, knowledge and culture have flowed in one direction or the other over time. During the 19th and 20th centuries, western-style science and technology were transferred through Japan to China, as Japan advanced in its modernization. But before that, over the centuries, Japan had learned a great deal from China. The legacies are still evident in many parts of our society today. For example, learning Chinese classical literature and poems is a part of student life in Japan. When I was a student, I remember struggling to recite poems written by Li Bai or Du Fu and reading Chunqiu or the Analects of Confucius. I would like to quote a phrase in Chinese that has remained with me over the years. 为穷而不困（Wèi Qióng Ér Bú Kùn）、忧而意不衰也（Yōu Ér Yì Bù Shuāi Yě） Never become troubled in adversity, never become depressed when worried. These are words from Xunzi. The calligraphy in Slide 1 was written by Yasushi Mieno, the 26th Governor of the Bank of Japan (BOJ), who had a deep understanding of China. He gave this calligraphy to me when I served as his secretary. These words were originally intended to explain the attitude toward learning. Mr. Mieno, however, found in them the importance of fulfilling the responsibilities of the central bank with determination. He always said "one should not run away even when faced with great adversity." Mr. Mieno enjoyed a good relationship for a long time with Liu Hongru, who was Deputy Governor of the People's Bank of China (PBC) at that time (Slide 2). Mr. Mieno once told me that, upon the two of them having drunk their hotel dry, Mr. Liu gave Mr. Mieno a nickname, "Mr. Prodigious Drinker (海量先生<Hǎi Liàng xiān sheng>)." As you are aware, Mr. Liu not only made great contributions to financial system reform in China, but also made efforts to establish and develop the Graduate School of the PBC, which is now the PBC School of Finance here at Tsinghua University. With these close connections in mind, today I would like to share Japan's experience and lessons learned from a central bank's perspective. The main themes of my speech are monetary policy and the financial system. On monetary policy, I will explain the transition of the BOJ's monetary policy instruments from the 1980s to the early 1990s in response to financial liberalization. On the financial system, I will talk about how Japan responded to the financial crisis that occurred after the collapse of the bubble economy and continued through the 1990s and the early 2000s. I will then close my speech by introducing an example of financial cooperation between our two countries; namely, the currency swap agreement between the BOJ and the PBC that was concluded last year. I. Monetary Policy: Toward Further Utilization of Interest Rate Instruments Let me start with a discussion on monetary policy. I would like to talk about the experience and lessons regarding the transition of the BOJ's monetary policy instruments in the process of financial liberalization. Japan's Experience Up until the mid-1990s, interest rates on bank deposits and loans in Japan were regulated based on the BOJ's loan rate to commercial banks. This loan rate was referred to as the official discount rate. At that time, the BOJ conducted monetary policy by adjusting the official discount rate. However, during the period of rapid economic growth, demand for funds constantly exceeded supply. It was difficult to control banks' lending activities by simply adjusting the official discount rate. For this reason, in 1957, the BOJ introduced an instrument that directly influenced banks' lending behavior. Specifically, it set the amount of loan growth for individual banks. This policy tool was called window guidance. At that time, this was a very effective monetary policy instrument. By the late 1980s, however, the effectiveness of window guidance declined. This is because, on the back of financial liberalization, the financial intermediary channel for the corporate sector became diversified and overseas funding expanded. To begin with, there was a prominent shift in corporate finance from bank loans to the issuance of corporate bonds (Slide 3). Furthermore, there was a rapid increase in lending by non-banks, which were difficult for the central bank to control directly (Slide 4). In addition, foreign currency and Euroyen lending, which was called "Impact Loans," also increased sharply during this period on the back of capital account liberalization (Slide 5). In response to these changes, the BOJ expanded the scope of window guidance to various types of bank lending activities. Nevertheless, managing the complex flow of funds of financial institutions amid financial liberalization was not feasible, and the effectiveness of window guidance declined. For this reason, the BOJ shifted from quantity control to interest rate control through open market operations. This is because interest rate instruments can affect not only bank lending but also overall financial activity. Window guidance was finally abolished in 1991. Implications for China In China, financial liberalization has made progress steadily in recent years. The size of the short-term money market and the bond market has been increasing. As a result, short-term interest rates, as well as primary and secondary interest rates on government bonds, are being formed in the financial markets. The benchmark interest rates set by the PBC still seem to have a certain impact on bank deposit and lending rates. However, the regulation, which requires that deposit and lending rates be kept within a certain range vis-à-vis the benchmark interest rates, has already been abolished. In addition, gradual capital account liberalization has made both overseas funding and investment easier than before. Under such circumstances, the PBC has been increasing the role of open-market operations in conducting monetary policy in recent years. At the same time, it also continues to use guidance such as macro-prudential assessment (MPA), which exerts a direct influence on bank lending. The PBC recognizes MPA as an important element of its financial control framework, which consists of monetary policy and macro prudential policy. In fact, Governor Yi Gang mentioned last December that China's monetary policy is still on the way of shifting from quantity control to price control and that quantity control remains very important at this stage.1 The current situation in China bears some similarities to that of Japan from the late 1980s to the early 90s when the BOJ increased the role of open market operations while giving a supplementary role to window guidance. Based on the BOJ's experience during the transition phase, I would like to emphasize the following three points. (1) Effectiveness of Central Bank's Guidance to Influence Bank Lending under Financial Liberalization The first point is that the effectiveness of direct control of bank lending inevitably declines as financial liberalization progresses. As I have mentioned, the effectiveness of window guidance by the BOJ decreased as firms diversified their funding sources on the back of financial liberalization. I would like to introduce my own experience related to this. In the late 1980s, I was part of a team at the BOJ responsible for implementing window guidance. At that time, Japanese banks were very active in providing loans. I still remember how they repeatedly emphasized that the demand for funds was strong on the back of robust economic activity. We tried to check whether that demand was based on sound economic activities or on speculative investments. We also examined whether the increase in bank lending was justified given the diversification of firms' funding sources. However, it was almost impossible to examine every single loan thoroughly. Meanwhile, once banks were granted a certain amount of increase in lending, they used up the full allotment. They took the approval by the BOJ as though they had been given the green light for an increase in loans. In addition, since the BOJ only controlled the increase in lending, the outstanding amount of bank lending itself always exceeded the previous year's result even though the BOJ asked for a restrained stance. As a result, bank lending and money stock continued to grow rapidly in the late 1980s (Slide 6). In retrospect, I think that the BOJ's window Gang Yi, "China's monetary policy framework: supporting the real economy and striking a balance between internal and external equilibrium," speech at the Tsinghua University in Beijing, December 13, 2018. guidance not only failed to adequately curb the expansion of credit but also contributed to the formation of the asset-price bubble to some extent. In China in recent years, corporate bond issuance has been increasing (Slide 7). Non-bank lending, often called shadow banking, has also been surging (Slide 8). In addition, there has been an increase in funding from foreign markets through the bond issuance by overseas subsidiaries (Slide 9). In this context, it is necessary to be well aware that the development of these alternative funding methods in China could make the central bank's quantity control less effective. (2) Financial Liberalization and Importance of Interest Rate Instruments for Monetary Policy The second point is that, as financial liberalization proceeds, interest rate control becomes more effective with a view to controlling financial conditions. It was not just because of the diversification of corporate funding channels that window guidance became less effective in the late 1980s. At that time, the BOJ was quite hesitant about raising interest rates due to several reasons, such as subdued inflation and fear of sharp appreciation of the Japanese yen. From 1987 through 1988, the BOJ required banks to take a disciplined lending approach through window guidance and gradually strengthened the guidance. However, with the official discount rate being unchanged, the effect was very limited. My sense is that the desirable policy effects could have been obtained if the official discount rate had been appropriately raised at that time. This is because changes in interest rates affect a wider range of financial activities, including those not directly affected by window guidance. Also, as liberalization of deposit and lending rates proceeds, banks' lending stance and firms' funding needs become more sensitive to changes in interest rates. Based on its experience, the BOJ shifted to interest rate control in conducting monetary policy. At the same time, the policy rate was changed from the official discount rate to the short-term market rate that should be guided through open market operations. At present, the PBC uses a quantity control instrument for exerting direct influence on bank lending while putting more importance on interest rate control through open market operations, as mentioned earlier. The former policy tool of quantity control plays an important role in supplementing interest rate-based monetary policy during the transition phase of financial liberalization. Nonetheless, based on Japan's experience, interest rate instruments need to be utilized with a view to affecting a wide range of financial activities, including bank lending. In this regard, the PBC announced this August that banks reporting the Loan Prime Rate (LPR), which is the reference rate for interest on bank lending, should determine their lending rates by referring to the rate of money market operations conducted by the PBC. The PBC also stated that all financial institutions should determine interest rates on new loans based on the LPR. The announcement is expected to make banks' lending rates change more flexibly than in the past, and it could lead to further utilization of interest rate instruments. (3) Importance of Developing Financial Markets The third point is that it is important to develop financial markets so as to raise the effectiveness of monetary policy using interest rate instruments. In order to increase the policy effectiveness of guiding short-term interest rates, the transmission mechanism of interest rates should be firmly established. In other words, changes in short-term interest rates in the interbank market need to be transmitted effectively through various interest rates, including the government bond yields. To achieve this, it is necessary not only to liberalize various interest rates, but also to improve the functioning of the financial markets and thereby facilitate arbitrage transactions across markets. In the case of Japan, the BOJ has made various efforts to develop financial markets. Our efforts focused not only on short-term money markets but also on bond markets and derivatives markets including futures (Slide 10). In China today, various financial markets are also being developed. In light of our experience, I would like to point out some issues that are particularly important going forward. First of all, increasing the diversity of market participants is critical. Liquidity of financial markets will improve when there are more transactions among diverse market participants with different business models, asset and liability structures, and views on the future course of interest rates. In addition to developing domestic institutional investors, encouraging entry by foreign financial institutions has great significance. In Japan, the entry of foreign financial institutions into bond markets has increased since the 1980s, and they have contributed to the smooth and flexible formation of both short- and long-term interest rates. Moreover, communication and cooperation between the central bank and market participants is vital. It is necessary to take into account the needs and burdens of market participants when establishing transaction rules, statistics, and payment systems. The BOJ has engaged in frank discussions with market participants through regular meetings and forums with specific themes. In this regard, it is very encouraging to see that such initiatives are already being taken in China. For example, financial markets have become increasingly open to foreign investors, especially since last year. Liquidity of financial markets will increase significantly as participation by foreign financial institutions increases. Furthermore, the relevant authorities, including the PBC, have started to make efforts to increase market liquidity, such as allowing more banks to trade bonds via stock exchanges. These efforts are expected to develop a market environment with enhanced market mechanisms. II. Financial System: Preparation for an Orderly Exit of Insolvent Banks from the Market Now, I would like to move on to the next theme, the financial system. Financial liberalization has a significant impact on the business environment and behavior of financial institutions. As the liberalization proceeded in Japan in the 1980s, financial institutions became concerned about the decline in profitability and the competition among them became fierce. As a result, they started lending aggressively, which eventually led to the creation of the asset-price bubble (Slide 11). After the burst of the bubble, Japan experienced a severe financial crisis and several major financial institutions failed. Let me review a series of events leading to the financial crisis. Japan's Experience After the burst of the bubble, small and medium financial institutions began to fail in 1991. The main cause of this was their excessive lending during the bubble period, and the consequent piling up of nonperforming real estate loans. In 1995, the resolution of non-bank housing loan companies, which had a significant amount of nonperforming loans, became a serious issue. At that time, however, the injection of public funds was not supported by the general public. Meanwhile, business conditions of financial institutions perceived as sound started to deteriorate. From 1997 to 1998, the default of a middle-sized securities firm triggered a series of failures of major banks and a major securities firm. In fact, the number of failures of Japanese financial institutions increased sharply in the late 1990s (Slide 12). In February 1998, belatedly, the necessary legislation was put in place to inject public funds into the financial system. However, the amount of public funds injected into major financial institutions was not sufficient and their soundness continued to deteriorate. Finally, a firm resolution framework was established in October 1998, for the smooth processing of failing financial institutions including temporary nationalization. Several major financial institutions with serious problems were nationalized temporarily, and a large amount of public funds was injected into other major financial institutions. In 2002, the Japanese government introduced a program that encouraged the acceleration of disposing nonperforming loans. With these measures, Japan's financial crisis finally took a turn for resolution. The nonperforming loan ratio started to decline (Slide 13). During the financial crisis, the BOJ provided necessary liquidity as the "lender of last resort." In addition, it provided equity-type funds such as capital and subordinated loans, which was beyond the traditional role of a central bank. These capital injections by the BOJ were unusual but necessary steps to prevent the materialization of systemic risk at the stage before the establishment of the aforementioned resolution framework, including the bailout by public funds. Implications for China In China today, the business environment of financial institutions is changing rapidly due to financial liberalization and the slower economic growth. In addition, with the heightened uncertainty about the global economy, the business conditions of financial institutions might be affected in the future. Given the relatively high level of debt, it is important to be well prepared for the potential risk that failure of individual financial institutions might become systemic and have a significant impact on economic activity. Based on Japan's experience, I would like to emphasize the following three points. (1) Importance of Establishing Financial Safety Nets The first point is the importance of building institutional frameworks that contribute to the stability of the financial system, namely, financial safety nets. In order to prevent failure of individual financial institutions from spreading through the financial system, it is necessary to have a quick and smooth resolution framework. In addition, various prudential schemes are needed for maintaining the soundness and confidence of the entire financial system. In Japan, a deposit insurance system was established at a relatively early stage in 1971. However, other key financial safety nets were introduced belatedly after Japan faced and dealt with the financial crisis caused by the burst of the bubble. The main examples of these safety nets included the resolution mechanism for financial institutions, the mandatory disclosure scheme on nonperforming loans, accounting standards for the adequate write-off of nonperforming loans, and the prompt corrective action framework (Slide 14). In the case of Japan, the government established these safety nets while dealing with the failure of financial institutions and the financial crisis. As a result, it took a long time to restore financial stability. In particular, there was no legal framework for injecting public funds into financial institutions. Moreover, in the beginning of the crisis, the general public was strongly opposed to the idea of injecting public funds. Therefore, business conditions of financial institutions deteriorated further until the injection was realized. In China, a deposit insurance system was established in 2015. Now, it is important to develop financial safety nets further while the financial system is sound. In this regard, China introduced measures this year to encourage financial institutions to increase capital through the issuance of perpetual bonds. This approach is in line with actions taken by other financial authorities around the world. At present, based on the experience of the global financial crisis, a common understanding among the authorities is that financial institutions should secure adequate capital on their own, relative to their size, rather than rely on public funds in the case of financial stress. In order to ensure the effectiveness of capital reinforcement, regardless of the source of funds, financial institutions need to monitor their own financial conditions carefully and, if necessary, raise capital proactively. In the case of Japan, since financial institutions initially underreported the amount of public funds they needed, the government was not able to inject sufficient funds for capital reinforcement at an early stage. This experience shows the importance of establishing an accounting standard of nonperforming loans and appropriate disclosure. (2) Dispelling the Myth that Banks Never Fail The second point is the importance of the recognition within society that, although individual financial institutions could fail, just like non-financial firms, the stability of the financial system can be maintained. If the general public perceives that "banks are fail-safe," a moral hazard is caused among depositors and banks, leading to the accumulation of risk for the financial system. Looking back, there was a myth in Japan that banks could not fail. In other words, the possibility of a bank's failure was not considered realistic. In fact, deposit insurance had not been triggered for 20 years, since its establishment until 1991. If we look back further, Japan experienced a severe financial crisis caused by a series of financial institution failures in the 1920s. Based on this experience, the Japanese financial authorities adopted an administrative approach called the "convoy system." This system strictly regulated competition among financial institutions with respect to interest rate setting and business operations in order to ensure that even financially weak institutions would not fail. The myth that Japanese banks could not fail was formed by this "convoy system" and by undue trust in financial authorities. In addition, there was another myth that land prices could never fall. In fact, the business conditions of Japanese banks were also supported by this "land price myth." It was not until the burst of the bubble and subsequent financial crisis that these two myths were debunked. Things changed all of a sudden, and the impact of a series of bank failures and the credit crunch in corporate finance on the Japanese economy was extremely severe. If there is a myth in China that banks never fail, it is important to dispel it in normal circumstances. At the same time, it is also important to build trust among the general public that financial stability as a whole will be maintained even if individual financial institutions fail. For example, one approach is to encourage financial education, including promoting better understanding of the deposit insurance system among the public. Until this year, China had not seen any bank failures since that of Hainan Development Bank in 1998. After Baoshang Bank was temporarily nationalized this May, there was a case of one major national bank acquiring an urban commercial bank. Accumulating examples like these would help raise social awareness of how the financial stability is secured apart from the failure of individual banks. (3) Deep Understanding of the Markets' Reaction The third point is that it is important to pay attention to how financial markets respond to various policy measures for strengthening financial stability. When faced with financial stress, the resolution of financial institutions, the disposal of a large amount of nonperforming loans, and financial system reform are inevitable in order to protect and strengthen the financial system. However, the authorities' actions could cause strong reactions by the financial markets, which might have counter-productive effects on financial stability itself. Let me introduce two cases from Japan's experience. The first case is the default of Sanyo Securities in the interbank market in 1997. Sanyo Securities, a medium-sized securities firm, was not a depository institution, and the amount of the default was relatively small. Nevertheless, the impact on the financial markets was significant. As this was the first-ever default in the Japanese interbank market since World War II, market participants became skeptical that those to whom they lent money might fail at any time. Financial institutions showed strong reluctance to provide even short-term funds, and as a result a severe credit crunch occurred. Actually, the financial crisis in Japan was triggered by this small default event in the financial markets. The second case relates to what was called the Japan premium. In 1997 to 1998, when a number of major financial institutions failed, Japanese banks were required to pay a premium for raising funds in U.S. dollars. At that time, the Japanese government was promoting deregulation of financial markets under the "Big Bang" reform programs and expediting the painful disposal of the nonperforming loans of financial institutions. Market participants were concerned about whether or not financial institutions were able to withstand the drastic reform and the disposal. In this situation, the Japanese banks, including even those with strong balance sheets, had to pay a premium of up to 100 basis points when raising funds in U.S. dollars. This was a heavy burden for the Japanese banks, and some market participants were concerned about a spillover of the financial crisis in Japan to the rest of the world, which fortunately did not happen. These examples show that financial markets sometimes react strongly to events when faced with financial stress. As a result, their reaction itself may amplify financial instability or make it difficult for the authorities to promote financial sector reform. In China today, the authorities have started to tackle the resolution of financially weak banks, as I mentioned earlier. They have also been promoting "financial supply-side structural reform" to further strengthen the financial system. Both efforts are steps in the right direction. However, when tackling the resolution and promoting financial sector reform, it is important to pay attention to the market's reaction, and to communicate carefully with the financial market. Conclusion Today, I have described Japan's experience and its implications for China by focusing on monetary policy and financial stability. In closing, I would like to talk about the importance of mutual learning and cooperation between Japan and China. At present, China is simultaneously facing a transition from rapid economic growth to slower growth, financial liberalization, and a declining birthrate and aging population. Japan has already experienced all of these events. Meanwhile, the two countries are now experiencing the same sorts of changes; for example, the digital revolution. In particular, the development of the digital economy in China has been remarkable, and this has drawn the attention of many Japanese companies. It will become more and more important for Japan and China to cooperate and learn from each other. In the beginning of my speech, I explained that knowledge and culture have flowed in one direction or the other between Japan and China over time. Compared with the past, the time now seems ripe for us to learn from each other by sharing our knowledge and experience. Furthermore, as the economic and financial ties between the two countries grow stronger, there are increasing opportunities for the two central banks to cooperate in addressing common issues. I will give you an example. In October of last year, the BOJ and the PBC signed a currency swap agreement, allowing for the exchange of local currencies between the two central banks of up to 200 billion renminbi, or 3.4 trillion yen (Slide 15). By utilizing the swap agreement, the BOJ would be prepared to provide liquidity in renminbi should Japanese financial institutions face unexpected difficulties in renminbi settlements, and vice versa with provisions of yen by the PBC. The agreement is designed to enhance the financial stability of the two countries, and hence support economic and financial activities for economic development in each country. Lastly, I would like to conclude my speech by referring to the words from Xunzi again. The passage that I mentioned in the beginning of my speech continues in this way (Slide 16). 知祸福终始而心不惑也（Zhī Huò Fú Zhōng Shǐ Ér Xīn Bú Huò Yě） This means that "the aim of learning is to understand misfortune and fortune, ending and beginning, and ultimately, to be able to guide yourself." In this world of great uncertainty, I feel that these words have marked relevance to the continuing efforts of Japan and China to learn from each other and deepen mutual cooperation. Thank you for your attention.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2019 Paris Europlace International Financial Forum, Tokyo, 28 November 2019.
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Haruhiko Kuroda: International financial regulation and supervision - past achievements, current issues, and future agendas Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2019 Paris Europlace International Financial Forum, Tokyo, 28 November 2019. * * * Introduction I am very honored to have the opportunity to speak at the Paris Europlace Financial Forum again this year. This is a valuable forum for exchanging ideas on interesting topics such as global financial regulation, financial innovation, and ESG, which are featured today. The forum also plays an important role in promoting Paris as a financial center. Turning to Tokyo, there is an ongoing effort to realize “Tokyo’s vision for a global financial city” and Mr. Nakaso, who appeared as a speaker earlier today, is leading this effort as chairman of the Organization of Global Financial City Tokyo. I think this is a valuable opportunity for interaction between the global financial centers of Tokyo and Paris. Over the past three years, I have talked about future challenges, such as financial innovation and demographic changes. This year, I will change focus slightly and look back on the discussions on regulation and supervision in the wake of the Global Financial Crisis, and then discuss issues that are currently of particular importance. I would also like to touch on issues that are likely to increase in importance in the future. I. Past, Present, and Future of International Financial Regulation and Supervision Since the Global Financial Crisis, financial institutions around the world have increased their capital adequacy ratios under new international financial regulations, such as Basel III. These regulations have been discussed and formulated by authorities worldwide and have helped increase the robustness of the global financial system. However, looking back on history, financial crises have repeatedly occurred in different forms, often with the advent of new financial technologies. As we are not crystal gazers and cannot foresee the future completely, we need to identify risks to the financial system in as forwardlooking a manner as possible. Based on a deep understanding of our past experience, we must monitor the progress of new financial innovation and changes in the environment surrounding financial institutions. We then need to design international financial regulations so that any risks identified do not lead to the next financial crisis. Even after global financial regulations have been carefully formulated and implemented, their effectiveness may be impaired by progress in financial technology and changes in the business environment. There is also the risk of unintended negative side effects that may demand further intervention if they outweigh the positive effects of any financial regulations. When designing global financial regulation and supervision, the following four-step cycle must be repeated: first, designing systems from a forward-looking perspective; second, steady implementation; third, evaluation of the positive effects and negative side effects, taking into account new technologies and changes in financial environment; and fourth, addressing any problems when necessary, such as when the negative side effects exceed the positive effects. Ten years have passed since the review of global financial regulations and supervision began in earnest after the Global Financial Crisis. In what follows, I will first assess the regulatory development work done during this period, particularly at the Financial Stability Board (FSB) and the Basel Committee. Then, among the work currently underway, I would like to highlight the importance of work on the evaluation of financial regulations. Finally, I will mention climate-related risk as one of the challenges for future financial stability. 1/4 BIS central bankers' speeches II. Past Achievements: Evaluation of Discussions over the Last 10 years After the Global Financial Crisis, work on reforming financial regulations started with a review of past crises, including the causes of each crisis. It revealed that before each financial crisis, there had always been a build-up of debt at financial institutions and in the non-financial sectors — socalled leverage build-up. Financial regulations were therefore strengthened in a forward-looking manner. For example, attention was focused on the credit-to-GDP ratio, which has implications as a leading indicator of potential problems. There has been much valuable progress in international financial regulation and supervision over the past 10 years, including Basel III. For example, an expansion of the Basel III framework was made in each of its three pillars: the first pillar being minimum requirement; the second pillar, supervisory review process; and the third pillar, market discipline through disclosure. In terms of content, policy tools such as liquidity regulations were expanded, in addition to the previous riskbased capital regulation. Also important was the introduction of a macroprudential perspective at the international level. Specifically, first, a countercyclical capital buffer (CCyB) was introduced in response to the issue of procyclicality over time; and second, the structural issue of the “too-bigto-fail” problem has been addressed by the introduction of a new framework for identifying global systemically important banks (G-SIBs) and a total loss-absorbing capacity (TLAC) framework. Both of these measures are key features of macroprudential policy: the first is seen as a response from a time-dimensional viewpoint of suppressing influence over time, and the second measure is a response from a cross-sectional viewpoint. III. Current Issues for International Financial Regulation and Supervision: Market Fragmentation Following the discussions described earlier, Basel III was finalized in December 2017. It is at present of paramount importance that each jurisdiction fully implements international agreements in a timely manner. After the finalization of Basel III, work continues in terms of both the confirmation of the intended effects of regulations and research into unintended effects, particularly in the FSB and the Basel Committee. The ongoing assessment work takes into account the interrelationships of multiple regulations in a more explicit way and adopts a more comprehensive and general equilibrium perspective. This continued assessment work is extremely valuable. The issue of “market fragmentation” is also crucial to this ongoing regulatory impact assessment work. That is why this issue was one of the policy priorities at this year’s Group of Twenty (G20) meeting under the Japanese presidency. Some of the financial regulations that have been designed over the past 10 years are likely to involve a degree of market fragmentation. As an example of market fragmentation, it is often mentioned among national authorities and market participants that regulatory responses to different OTC derivative trading markets in each country have an impact on global derivatives market trading. Unintended forms of market fragmentation may arise as the details of regulations and the timing of their implementation differs across countries.1 Unintended market fragmentation should be avoided because it can have a negative effect on the stability and efficiency of the financial system. Market fragmentation is an important consideration when conducting analysis-based policy evaluations, and its discussion with a highlevel consideration in international forums is to be welcomed. V. Future Agendas of International Financial Regulation and Supervision: Environmental Problems as a New Financial Stability Issue The progress made over the past 10 years is something to be proud of, but we must not rest on our laurels. There are issues remaining for financial institutions other than banks — for example, non-bank financial intermediaries that are subject to less stringent regulations. The banking 2/4 BIS central bankers' speeches sector itself is undergoing changes in its business model due to the effects of digitalization and other factors. These are situations that require continuous monitoring. Therefore, it is necessary to continue the steady implementation of the four-step cycle mentioned earlier. Against this background, I would like to mention climate-related risk as an example of a new issue for financial stability. Nationwide efforts have continued in the recovery from the damage caused by Typhoon No. 19 and the ensuing floods in October this year, and there has been an increase in Japan in recent years in severe natural disasters, such as typhoons. It may not be easy to establish a causal relationship, but some have pointed to global warming as a cause of the increase in catastrophic natural disasters. While it is human lives that are ultimately at stake, the impact of such disasters may also lead to a decrease in asset value and collateral value, and the associated risk may come to be a significant challenge for financial institutions. Climate-related risk differs from other risks in that its relatively long-term impact means that the effects will last longer than other financial risks, and the impact is far less predictable. It is therefore necessary to thoroughly investigate and analyze the impact of climate-related risk. If any regulatory or supervisory response is required, the four-step cycle mentioned above should be implemented carefully: systems must be designed from a forward-looking perspective, implementation must be steady, the positive effects and negative side effects must be evaluated, and any problems must be addressed as necessary. In considering the regulation and supervision of climate-related risk, it is necessary to keep in mind to what extent industrial policies and environmental regulations and guidelines are effective in addressing such risks. Therefore, there may be room in this case for cooperation between the industrial sector and the financial sector. Climate-related risk raises both cross-sectional and time-dimensional issues: the crosssectional problem is that carbon emissions affect a wide range of industries, and the timedimensional problem is that this effect is a long-term problem. In the context of financial regulation and supervision, we have shown our expertise in addressing cross-sectional and timedimensional problems through our response to the “too-big-to-fail” issue and in the design and operation of CCyB. In addressing environmental risks as a new issue in financial stability, the wealth of previous discussions on financial regulation and supervision may provide some valuable insights. Let me also note that there is the Network for Greening the Financial System (NGFS) as a place for global discussions related to the issue of climate change. The Bank of Japan has joined this network and is looking forward to working with the NGFS member institutions and contributing to the discussions. Our decision to seek membership of the NGFS was greatly encouraged by our dialogues with Governor Villeroy de Galhau, who is also here today, and other colleagues at la Banque de France, an institution that has always taken strong international leadership in this area. Concluding Remarks In my speech today I have mentioned climate-related risk as a new issue in considering financial stability. There are many other challenges that need to be addressed, such as cyber risk, antimoney laundering (AML), countering the financing of terrorism (CFT), and the issue of crypto assets. In addressing these new challenges, I think it is important to continue implementing the four-step cycle that has been repeatedly mentioned today. Let me conclude with a quote from a French mathematician Henri Poincare: “Mathematics is a technique that regards different things as the same."2 Even if they seem to be different on the surface, things often share a common essence. Thank you for your attention. 3/4 BIS central bankers' speeches 1 See for example in the OTC derivatives markets, Financial Stability Board, “FSB Report on Market Fragmentation,” June 2019. 2 Jules Henri Poincare, Kagaku to Hoho , trans. Yoichi Yoshida (Tokyo: Iwanami Bunko, 1953), 37. 4/4 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, 19 November 2019.
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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, 19 November 2019. * * * Introduction The Bank of Japan submits to the Diet its Semiannual Report on Currency and Monetary Control every 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 I will first explain economic and financial developments in Japan. Japan’s economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports, production, and business sentiment have continued to be affected by the slowdown in overseas economies. Looking at this in more detail, Japan’s exports have continued to show some weakness amid continuing slowdowns in overseas economies. On the other hand, domestic demand has increased. Specifically, with corporate profits staying at high levels on the whole, business fixed investment has continued on an increasing trend. Private consumption has been increasing moderately, albeit with fluctuations due to such effects as of the consumption tax hike. As for the outlook, Japan’s economy is likely to continue on an expanding trend, as the impact of the slowdown in overseas economies on domestic demand is expected to be limited, although the economy is likely to continue to be affected by the slowdown for the time being. On the price front, the year-on-year rate of change in the consumer price index (CPI) has been positive but has continued to show relatively weak developments compared to the economic expansion and tight labor market conditions. With regard to the outlook, although the year-onyear rate of change in the CPI is expected to be affected by such factors as the decline in crude oil prices for the time being, medium- to long-term inflation expectations are projected to rise with the output gap remaining positive. Thus, as the momentum toward achieving the price stability target is maintained, the year-on-year rate of change in the CPI is likely to increase gradually toward 2 percent. II. Conduct of Monetary Policy Next, I will explain the Bank’s conduct of monetary policy. The Bank has been conducting powerful monetary easing under the framework of “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control.” In terms of yield curve control, with a view to facilitating the formation of the yield curve that is considered most appropriate for achieving the price stability target, the Bank has conducted purchases of Japanese government bonds (JGBs) under the guideline for market operations, in which it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year JGB yields at around zero percent. Although it is likely that Japan’s economy will continue on an expanding trend and the year-onyear rate of change in the CPI will increase gradually toward 2 percent, the Bank considers it necessary to continue to pay close attention to downside risks, particularly regarding 1/2 BIS central bankers' speeches developments in overseas economies. Based on this recognition, the Bank deems it appropriate to take the policy stance of being tilted toward monetary accommodation. At the Monetary Policy Meeting held in October, the Bank decided on a new forward guidance for the policy rates and clarified its stance to maintain the present levels of the policy rates or, depending on the situation, lower them from the present levels, as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. Under this policy stance, the Bank will continue to pursue powerful monetary easing toward achieving the price stability target. In doing so, the Bank considers it important to take into account both the effects and side effects of monetary policy, including those on financial markets and the functioning of financial intermediation. On this point, the Bank recognizes that prolonged downward pressure on financial institutions’ profits, with the low interest rate environment and severe competition among financial institutions continuing, could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. Although these risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases, the Bank will continue to examine these risks as well as those considered most relevant to the conduct of monetary policy and conduct its policy in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. Thank you. 2/2 BIS central bankers' speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Symposium for the 35th Anniversary of the Center for Financial Industry Information Systems, Tokyo, 4 December 2019.
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December 4, 2019 Bank of Japan Payments Innovations and the Role of Central Banks: Addressing Challenges Posed by Stablecoins Speech at the Symposium for the 35th Anniversary of the Center for Financial Industry Information Systems Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) I. Introduction It is my privilege to be here today at the Symposium for the 35th Anniversary of the Center for Financial Industry Information Systems (FISC). Since its foundation in 1984, FISC has contributed enormously to enhancing financial information systems and to improving the efficiency of financial services in Japan. I would like to express my respect for FISC's many years of service and extend my heartfelt congratulations on the 35th Anniversary. Today, I would like to talk about payments innovations and the roles of central banks. Recently, there have been various changes in Japanese retail payments: person-to-person payments and merchant-to-person payments. For example, in October 2018, financial institutions started to provide their customers with "24/7 fast payment services," which enables real-time fund transfers between deposit accounts on a 7-days-a-week, 365 days-ayear basis, including nighttime and holidays. The providers of these services have aimed at responding to the demand for more convenient payment services arising from changes in the lifestyle of consumers and the spread of e-commerce. In addition, when we look at the payment interfaces between consumers, merchants, and payment service providers, a wide variety of devices, such as smartphones and IC cards, have become available. Not only financial institutions but also various agents such as nonbank firms with strengths in IT -- so called FinTech firms -- have started to provide cashless payment services. This is also a significant change surrounding payment services in recent years. Since this October, the Japanese government has introduced the point reward program for consumers using cashless payments. It aims to improve the productivity of relevant businesses and to increase the convenience of consumers through further dissemination of cashless payments. The Bank of Japan has received several comments from its nationwide branch offices that the government's program has helped increase cashless payments. This year, we have never run short of news on payments, but the one that attracted most attention was Facebook's stablecoin initiative, "Libra." Stablecoins have emerged as an alternative to crypto-assets, whose severe price volatility has made them difficult to use as payment instruments. Numerous types of private digital money have emerged to date across the world, but Libra differs in some aspects. With its large customer base built by Facebook, Libra has the potential to find wide global use as a private currency denominated in its own unit of account. Global stablecoins (GSCs), such as Libra, may offer convenient payment services to many users, if legal certainty and technical stability are ensured. However, users cannot continuously appreciate the benefits of GSCs unless various challenges and risks related to money-laundering, cyber-security, data protection, and consumer and investor protection are properly addressed. The spread of GSCs could have significant implications on the financial system and the transmission of monetary policy. As pointed out in the G7 working group report on GSCs, no GSC project should begin operation until the legal, regulatory and oversight challenges as well as associated risks that are outlined above are adequately addressed.1 This view was also shared at the G20 Finance Ministers and Central Bank Governors Meeting. Today, I would firstly like to discuss the public authorities' response to GSCs in terms of "global governance" in ensuring the stability of the global financial system. To maintain the global financial stability with free capital mobility, the authorities need to cooperate to establish globally consistent rules and regulations and require issuers of GSCs to comply with these rules. It is important to understand what impact GSCs could have on a supply channel for a global public good, "financial stability." I would then like to mention the challenges in improving the existing retail payment services. The emergence of private sector innovations, including GSCs, highlights shortcomings in the existing payment systems. For example, cross-border payments remain slow and expensive. The authorities should not only highlight risks and issues posed by the emergence of new digital money, but also encourage improvement of the existing payment systems. As mentioned earlier, while new means of payment have emerged and have demonstrated efforts to enhance customer convenience in Japan, there remain various challenges toward the wider use of cashless payments. In this regard, today, I would like to focus on the interoperability of payment services. G7 Working Group on Stablecoins, "Investigating the impact of global stablecoins," October 2019. II. GSCs in terms of Global Governance Supervisory and regulatory authorities and central banks have recognized the need for close international coordination and collaboration, rather than individual effort, to address the issues of GSC initiatives, such as Libra. The idea of the "financial trilemma" could help us understand why the authorities agree on this view.2 Financial Trilemma The financial trilemma states that the following are incompatible: (1) financial integration under free capital mobility, (2) financial stability, and (3) national financial policies. Any two of the three objectives can be combined but not all three; one has to give. For example, let us take the case where each jurisdiction maintains its own national financial policies in a financially integrated world. In a lightly regulated jurisdiction, financial institutions would tend to take on more risks and engage in risky business overseas. Firms and households in that jurisdiction would increase borrowing, including foreign currency denominated borrowing. Such increased leverage could eventually lead to financial instability. In sum, when "financial integration" and "national financial policy" are chosen, "financial stability" must be sacrificed. To achieve financial stability in the financially integrated world, the authorities need to give away their national financial policies and cooperate with other countries to introduce globally consistent financial policy. GSCs are digital tokens issued against funds collected from customers all over the world. The reserve of funds would be invested in a basket of major fiat currencies, consisting of government securities and bank deposits. Using GSCs as a means of cross-border payment would further facilitate and promote cross-border capital flows. Taking these points into account, GSCs can be interpreted as a scheme that would deepen financial integration. Therefore, to maintain financial stability, which could be undermined by the emergence of GSCs, globally consistent financial policy is indispensable. That is the reason why the financial authorities and central banks have been coordinating and discussing how to address the issues raised by GSCs since this summer. Schoenmaker, D, "The financial trilemma," Economics Letters, 2011 vol.111, 57-59. Given the enormous benefits derived from global financial activities, the private sector entities have a strong incentive for regulatory arbitrage. Even if transactions in GSCs are prohibited in some jurisdictions, they may expand in other lightly regulated jurisdictions. In times of stress, this could bring adverse effects on the global financial market as a whole. For example, even if GSCs are not widely used in advanced countries, an increase in transactions of GSCs in emerging markets could subsequently increase the reserve assets, consisting of government securities and bank deposits issued in advanced countries. Once the credibility and reputation of GSCs are significantly undermined, or the value of the reserve assets decreases, customers could rush to request redemption of GSCs for fiat currency. As a result, the issuers of GSCs would be forced to withdraw bank deposits or sell government securities, increasing the volatility and vulnerability of the financial markets in advanced countries. To mitigate such risks, supervisory and regulatory frameworks of relevant jurisdictions need to be mutually consistent and discourage regulatory arbitrage of GSC issuers. Legitimate and sound fund transactions are the basis for financial stability and financial integration, and therefore, measures against money laundering and those to counter the financing of terrorism (AML/CFT) need to be implemented consistently across jurisdictions. Furthermore, an overarching approach to global coordination, including the areas of cyber-security, data protection, and consumer and investor protection would be necessary. Financial Stability as a Public Good Financial stability is an essential "public good" for firms, individuals and financial institutions to engage in economic activities. Public goods have two features. One feature is that consumption by an individual or a group of individuals does not reduce the good's availability to others.3 The other feature is that the good is available to all and cannot be withheld, even from people who do not pay for the goods.4 As people are not required to pay for public goods regardless of how much they consume, a free-rider problem could arise. Therefore, if the supply is left solely to the market, these goods will not be provided. Financial stability can be considered to have such features. For this reason, supervisory and regulatory authorities and central banks ensure that public goods (i.e. financial and monetary stability) In traditional economics, this feature is referred to as "non-rivalry." This feature is referred to as "non-excludability." are provided through monetary policy and prudential policy by establishing adequate regulatory frameworks. GSCs aim to stabilize their value by linkage to a basket of fiat currencies of the major countries. In other words, the scheme of GSCs utilize a global public good (i.e. global financial stability), which is made up of a basket of public goods of each jurisdiction. Global financial policy can be interpreted as constituting rules for the appropriate consumption of global public goods. Therefore, GSC issuers need to comply with the rules, because they provide payment services using global public goods. If GSC issuers were to overconsume a public good (i.e. global financial stability) and expand business beyond their risk management capacity, it could cause stress in the global financial markets, such as rapid capital flight, when risks materialize. As a result, the public authorities would be forced to incur additional costs for providing a public good (i.e. financial stability). For example, the central bank, as a lender of last resort, would provide liquidity, or the government would step in to take fiscal measures. Looking back on the era of "Great Moderation" up until the mid-2000s, US and European banks rushed to take on excessive risks. Although they were subject to financial regulations at that time, many of them simultaneously became overconfident about future financial stability and held optimistic views on risk. Such risk perception led to credit expansion and asset price increases in a synergetic manner. In the wake of the subsequent Great Financial Crisis, financial authorities established the macro-prudential regulatory framework, which put in place more stringent rules regarding the appropriate consumption of a public good (i.e. financial stability). While regulations on banks were strengthened after the Great Financial Crisis, nonbanks such as investment funds expanded their presence in the market of "credit intermediation," mainly in US and Europe. Meanwhile, Facebook's GSC initiative, Libra, could be an example of nonbank efforts to replace banks and increase their presence in the market of "payments." Regardless of whether they carry the function of credit intermediation or payments, not only banks but also nonbanks need to comply with the rule of the appropriate consumption of public goods. GSCs and the Financial Version of the "Tragedy of the Commons" As I have mentioned earlier, one of the features of public goods is that consumption by an individual or a group of individuals does not reduce the good's availability to others. For example, no matter how much air (i.e. public good) I breathe in, it does not limit your air consumption. So, you may wonder why I am warning about the overconsumption of a public good (i.e. financial stability), by GSC issuers. Simply put, the reason is that a wide use of stablecoins in a global scale could transform financial stability from a "public good" into a "common-pool resource." A common-pool resource has the same feature as public goods in that it is available to all and cannot be withheld, even from people who do not pay for the resource. But unlike public goods, consumption by an individual or a group of individuals does reduce the resource's availability to others. 5 A typical example is fishery resources. Overconsumption of a common-pool resource can lead to the complete and permanent destruction of the commonpool resource. This problem is known as the "tragedy of the commons."6 When farmers put their cows on a common pasture, each individual farmer will put as many cows on the pasture as possible, acting independently according to his own self-interest. This will eventually result in the over-exploitation and destruction of the pasture, and all farmers will be damaged. GSCs could bring about a "tragedy of the commons." Central banks provide public goods (i.e. financial and monetary stability) through monetary and prudential policies. Meanwhile, GSC is a scheme that utilizes public goods (i.e. financial and monetary stability), provided by central banks. If GSCs are widely used with over-exploitation of public goods in such a way that GSCs begin to substitute for fiat currency in each jurisdiction and GSC-denominated transactions and assets/liabilities increase, this would undermine the monetary policy transmission of central banks. When the effects of monetary policy are weakened, the While a public good satisfies both "non-rivalry" and "non-excludability," a common-pooled resource exhibits only "non-excludability." 6 Hardin, G, "The Tragedy of the Commons," Science, 1968, vol.162, 1243–1248. provision of public goods (i.e. financial and monetary stability) will be disturbed, and this would destabilize not only the value of GSCs but also overall economic activities. This can be thought of as the financial version of a "tragedy of the commons." A wide use of stablecoin on a global scale could transform financial stability from a public good into a common-pool resource. The risk of currency substitution to GSCs could be higher for countries with a weak economic base and lacking effective payment infrastructures. When the effects of monetary policy are undermined by the spread of currency substitution across these countries, it would lead to instability in the real economy, the impact being transmitted to other countries. Given the progress in economic globalization and stronger interdependencies among financial systems, there is a risk that the financial markets of advanced economies would also be subject to instability. As a result, the provision of a global public good (i.e. global financial stability), would be reduced, and a tragedy of the commons could occur. The public authorities, in coordination with other domestic and foreign authorities, need to address various challenges posed by GSCs, including the tragedy of the commons. III. Reform of Retail Payment Systems As described above, GSCs could have significant implications for the international monetary system and settlement system. They should not begin operation until the various challenges and risks are adequately addressed. At the same time, I would like to assert that the Bank of Japan takes the position of promoting private sector innovations. The recent GSC initiative has posed us challenging questions: What are the shortcomings of the existing payment services? What are the remedies? This is an inevitably important issue for a central bank responsible for improving efficiency and safety of the payment and settlement systems. There are many issues in the current payment and settlement systems that must be dealt with, such as costly cross-border payments and financial inclusion. It is vital for us to understand that the advent of private sector innovations derives from issues originating in the existing payment and settlement systems. Network Effects and Interoperability Costly cross-border payments and financial inclusion are not the only issues that need to be addressed. While major advanced countries have been upgrading their domestic retail payment systems by adopting 24/7 fast payment services, there is more room for improvement. This is obvious when we consider why GSCs have attracted so many people's attention. For example, Facebook has over two billion users, and they are all potential users of Libra. Benefits from payment services become more valuable when more people use them. This is known as "network effects." It is easy to predict that the Libra platform, with its huge customer base, will leverage network effects significantly. Many studies have attempted to carry out quantitative analyses of the benefits of network effects, and one of the prevailing views is "Metcalfe's law." The law states that the value of a network is proportional to the square of the number of users participating in it. In fact, some studies have shown that Metcalfe's Law is a good quantitative explanation for the value of Facebook's platform. 7 In terms of network effects, it seems that the customer bases of existing payment service providers in each country are inferior to Libra's potential customer base. However, while platforms with strong network effects can offer considerable benefits to users, platforms can create monopoly problems by locking in users. In other words, if the number of users and merchants participating in the network exceeds a certain size (critical mass), the scale of the payment platform will expand rapidly due to the network effect, which may lead to an oligopoly or monopoly of the market. If a particular provider becomes a dominant player in the retail payment services market, problems such as distortions in the pricing system and reduced incentives for innovation may eventually arise. Monopolies impede competition and innovation, and can ultimately have a negative impact on consumer benefits. At first glance, it seems difficult to achieve both the benefits of network effects for users and the long-term benefits for society through competition and innovation. But it is not impossible. "Interoperability" between payment service providers and platforms can help achieve both Zhang XZ, Liu JJ, Xu ZW, "Tencent and Facebook data validate Metcalfe's law," Journal of Computer Science and Technology, 2015, vol.30 (2): 246–251. these goals. Interoperability across multiple platforms enables a customer participating in one platform to make payments to customers on other platforms. This greatly improves user benefits gained from network effects. The network effect based on interoperability arises from the collaboration among multiple payment service providers and multiple platforms, and it is not provided exclusively by a single payment service provider or platform. By ensuring interoperability, payment service providers such as banks and FinTech firms can expand the overall market size of cashless payments and achieve a win-win relationship among them. Also, the payment service providers can still compete by combining payment services with other financial and non-financial services and create their own unique added value. Payment service providers will be released from launching endless discount campaigns to lock in customers and will instead be able to look ahead toward the creation of new value. Such competition will drive innovation, too. In this way, collaboration among payment service providers by ensuring interoperability will promote both competition and innovation while avoiding monopoly problems. Strategies of FinTech Firms Now, let us look at interoperability in Japan's retail payment systems. What are the challenges? I would like to consider this topic from the perspective of the payment business strategies of FinTech firms and banks. Firstly, the strategies of FinTech firms. There are a number of payment platforms operated by FinTech firms, and competition among them has become quite fierce. Several FinTech firms have already developed radical strategies to lock in customers, such as rebates and reduction of the merchant discount rate. These strategies are designed to scale up the platform as fast as possible and achieve a critical mass. While such strategies are rational on their own, they could be risky when a strong rival exists, as they may not be as effective as expected and FinTech firms may be worn out. In Japan, the biggest rival of cashless payment service providers is banks' branches and their CD/ATM networks supporting cash payment. Japanese banks maintain geographically dense networks of branches and ATMs, enabling people to withdraw cash from their accounts very easily.8 Bank of Japan, Payment and Settlement Systems Report (March 2019). What makes cash payment convenient is not only the number of bank branches and ATMs. The interoperability of ATM services across banks also contributes to this. It allows customers of one bank to withdraw cash from ATMs of another bank. In Japan, it is undeniable that FinTech firms' payment platforms pale in comparison to cash networks in terms of interoperability. Recently, some improvements have been made to FinTech firms' platforms, such as the standardization of QR codes and merchant sharing, but overall, there remains more room for improving the interoperability of their payment services. Retail Payment Strategies of Banks Regarding retail payment strategies of banks, the following two common points have been observed. Firstly, banks provide FinTech firms with access to their customers' deposit accounts and offer account transfer services. In order for customers to use FinTech firms' cashless payment services, they need to top up from their bank accounts or to use a bank account debit function. In some sense, bank accounts and payment services provided by FinTech firms can be regarded as complements, like coffee and sugar. If you compare coffee with sugar sachets attached and coffee without sugar sachets, the former is preferable. Similarly, between bank accounts linked to FinTech firms' payment services and bank accounts that are not, the former is preferable for customers. From the viewpoint of competition among banks, those providing account transfer services to FinTech firms have an advantage in attracting new customers and/or preventing existing customers from closing or deserting their accounts. Secondly, banks participate in cashless payment platforms operated by the banking industry, competing with FinTech firms. As cashless payments through FinTech firms become more prevalent, the banks might face the greater risk that they will be a mere provider of deposit accounts and thus lose a close relationship with customers and merchants. If banks want to access customers' payment information and merchants' sales information, banks need to provide payment services to customers at the front end. This is the reason why banks have an incentive to participate in cashless payment platforms operated by the banking industry. In some sense, the payment services provided by banks and those provided by FinTech firms could be viewed as substitutes, like coffee and tea. These two strategies are rational choices for each individual bank in terms of competition with other banks and with FinTech firms respectively. However, if many banks follow the same strategies, the "fallacy of composition" could arise, and the combined effects of the two strategies may be lower than expected, namely, one plus one being less than two (1 + 1 < 2). While banks support FinTech firms' payment services by providing them with real-time account transfer service, they act as acquirers themselves and seek out merchants who will join payment platforms operated by the banking industries. However, since FinTech firm and bank payment platforms lack interoperability, none of these platforms is likely to grow significantly, making it difficult for banks to recoup their investments. Collaboration Among Payment Service Providers When multiple payment platforms exist but lack interoperability, payment service providers, both FinTech firms and banks, have a strong incentive to lock in customers in order to beat the competition. This may lead to fragmentation of payment services, undermining network effects and user convenience. As a result, banks and FinTech firms would end up wearing themselves out in the process. Especially in Japan, where there exist very efficient cash services supported by geographically dense networks of CD/ATMs with a high-level of interoperability, payment service providers must devote a significant amount of resources to expanding the market for cashless payment services. However, the expansion is unlikely to be achieved if FinTech firms and banks act separately in pursuing their own cashless payment services. In such a situation, a desirable option is that payment service providers collaborate with each other – that is, make their services interoperable – in order to maximize the network effects of digital yen. Collaboration among payment service providers can take various forms: between banks, between FinTech firms, and between banks and FinTech firms. At first glance, interoperability may seem like giving away the benefit to the other parties. That would be true if the market for cashless payment services does not scale up even with the introduction of interoperability. It would simply escalate the competition among payment service providers. However, if interoperability among payment service providers and payment platforms is ensured, benefits to users will increase, leading to an increase in the use of cashless payments, hence the expansion of the market for cashless payment services. As a result, a win-win relationship benefitting all the payment service providers can be established. Many studies have indicated that network interoperability will bring a win-win relationship between related parties.9 In fact, this has also been proved by some examples that are quite familiar to us. One of them is the interconnection of transportation IC cards, such as PASMO and Suica. As this has improved convenience for users, the cumulative number of transportation IC cards issued has now surpassed 100 million. The advantage for users (riders) that they do not have to buy a ticket each time they travel is also an advantage for transportation companies, since they do not have to sell a ticket for each journey. The interconnection of transportation IC cards has made it possible for each transportation company to save labor costs in checking tickets, fares, and commuter passes. This has led to punctual operation (as the result of efficient boarding), reduction of the human workload, and optimization of human resources. There is also an interesting example regarding interoperability in the banking sector; the CD/ATM network. In 1980, city banks divided themselves into two tiers, the upper tier and the middle and lower tier, and initiated an online network alliance separately for each tier group. The division into two tiers was said to be the result of opposition by banks in the middle and lower tier. They were concerned that "if online networks are integrated into one alliance, customers will move their bank accounts to the upper tier banks, and the middle and lower tier banks will be left to serve only as providers of machines."10 However, the advent of a nationwide online network for postal savings, which was the banks' common and strong rival, eventually pushed these two tiers to integrate. In 1984, a new city bank cash service (BANCS) was launched by unifying the two tiers. After that, the multi integrated cash service (MICS) was launched by integrating the networks of city banks and regional banks. The Benson, C and S Loftesness, "Interoperability in Electronic Payments: Lessons and Opportunities," CGAP, 2012. Clark, D and G Camner, "A2A Interoperability - Making Mobile Money Schemes Interoperable," GSMA, February 2014. 10 The Yomiuri Shimbun, "Jidou shiharai, dono togin demo" [Interoperation of CD/ATMs deployed among city banks], news article, February 19, 1986. interoperability of CD/ATM services across banks did not create any particular losers, and many banks found that the number of deposit accounts they provide increased, resulting in a win-win situation for everyone and more convenient services for users. This has led to the convenience of cash payments today. These examples demonstrate that ensuring interoperability is critical for improving retail payment services in Japan. For the widespread use of cashless payments, payment should be stress-free for consumers and merchants, and interoperability of payment networks is an essential element. Specifically, there are various options, such as interconnection among payment platforms, participation of payment providers on a common platform, standardization of payment terminals, retail point of sale compatibility, and merchant sharing. When we look overseas, interoperability is the common feature of countries where cashless payments are widely used. For example, there are a number of payment platforms enabling customers to transfer money instantly on a 24/7 basis using mobile phone numbers. 11 Banks participating in these systems share a common database linking customers' bank account numbers to mobile phone numbers. There are also some cases where nonbanks such as FinTech firms participate with banks in the same payment system. 12 As the recent GSC initiative has highlighted the necessity for more convenient services, we should start to seriously discuss and consider possible solutions in the Japanese market. I would like to encourage relevant parties to put their proposals on the table. IV. Concluding Remarks Today, I have discussed the challenges and risks posed by GSCs as well as the need for the reform of retail payment systems. While GSCs have the potential to improve payment services, their widespread use and the increase in GSC-denominated transactions could undermine the effects of monetary policy transmission and financial system stability. Therefore, the public authorities, as providers of Bank of Japan, Payment and Settlement Systems Report, March 2019. For example, in Hong Kong, HKICL began operation of the "Faster Payment System" 24/7 realtime payment service in 2018. Participants in the system are major banks and Stored Value Facilities (FinTech firms). a public good (i.e. financial stability), need to not only support private sector innovations but also promote the use of digital money denominated in a fiat currency in their jurisdictions. This brings me to another important issue. Should central banks issue digital money, central bank digital currencies (CBDCs)? To date, many central banks around the world have already been engaged in research activities for CBDCs. In some European countries, central banks have been encouraged to accelerate work on issues surrounding possible public digital currency solutions in order to counter private sector initiatives in stablecoins. In Japan, the amount of cash outstanding is still increasing, and it does not seem that there is a demand for CBDC from the public at present. Nevertheless, the Bank of Japan has been conducting technical and legal research on this matter in order to stand ready when the need for CBDC may arise in the future13. The Bank also needs to study the impact of CBDCs on financial intermediation. Currently, there is a wide variety of private digital money denominated in Japanese yen. It is very important to promote the use of such private money by improving its functions to bring it closer to the expected functions of CBDC. In this regard, the network effect through the increase in the number of cashless payment users is a key to improving the convenience of private digital money. It is more desirable to gain such a network effect through the interoperability among multiple payment service providers and platforms rather than by a single payment service provider or platform alone. If interoperability between private digital money increases, private money will approach more closely to central bank money in terms of general acceptability. In addition, the wide use of private digital money denominated in Japanese yen, which would be enhanced by competition and coordination among payment service providers, could help the Bank of Japan maintain the channels for providing public In technical aspects, the Bank has been conducting research on new technologies, including distributed ledger technology (DLT). For example, the joint research project with the European Central Bank, "Project Stella" is being carried out as part of our research. In legal aspects, the Bank has been working to explore the potential legal issues and implications that may arise from the issuance of CBDC in Japan. For more information, see "Report of the Study Group on Legal Issues regarding Central Bank Digital Currency (Abstract)," Institute for Monetary and Economic Studies, Bank of Japan, September 2019. goods (i.e. financial and monetary stability). This is desirable for the national economy as a whole. The Bank of Japan, as the operator of the BOJ-Net and as a catalyst promoting dialogue in the private sector, will continue our efforts toward the greater efficiency and safety of payment systems. Thank you very much for your attention.
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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, Hyogo, 27 November 2019.
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November 27, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Hyogo Makoto Sakurai Member of the Policy Board (English translation based on the Japanese original) I. Economic Activity at Home and Abroad A. Recent Developments in Overseas Economies Let me start with developments in overseas economies. The global economy has continued to grow moderately, but the pace of growth has been decelerating since the start of 2019. According to the October 2019 World Economic Outlook released by the International Monetary Fund, the global growth rate for 2019 is projected to be 3.0 percent, a lower rate compared to 3.8 percent for 2017 and 3.6 percent for 2018 (Chart 1). The continued deceleration is mainly due to a significant slowdown and stagnation in world trade volume caused by the intensified U.S.-China trade conflict. This has exerted downward pressure on the Chinese economy, which is one of the hubs of global supply chains, and its effects are spreading across the global economy, including Japan. Looking at developments by region, the U.S. economy has expanded moderately, albeit at a somewhat slower pace. No significant problems have been observed in U.S. economic fundamentals, with solid consumption sustained amid the historically low unemployment rate, and an increase in housing investment mainly due to lower interest rates. The European economy has been in low growth, partly reflecting the effects of the economic slowdown in China, one of the euro area's main trading partners, in addition to confusion over the United Kingdom's exit from the European Union. Emerging economies have shown mixed movements, but in Asian countries -- where economic ties with China are deep -- global trade issues have affected production and exerted downward pressure on growth in these economies. Given the ongoing U.S.-China trade conflict and heightened geopolitical risks worldwide, it is unlikely that uncertainties regarding the outlook for the global economy will be dispelled soon. Some of these regions are proceeding with policy actions amid growing concerns over the outlook for the global economy. For example, additional easing measures have already been implemented in the United States and Europe, and economic stimulus measures have been taken in China. These policy actions have been effective in underpinning economic activity to a certain extent; however, they are not strong enough to outweigh the impact of the U.S.China trade conflict, which has been more extensive and prolonged than initially anticipated. B. Outlook for Overseas Economies Concerns remain that overseas economies may decelerate even further due to the impact of the intensified and prolonged U.S.-China trade conflict. However, there are potential upside risks as well. For example, economic measures implemented so far may show a greater influence in the first half of 2020 than initially anticipated, and the reorganization of supply chains in response to the trade conflict may accelerate. As I have already mentioned, the current slowdown in global economic growth has been mainly induced by the significant slowdown in world trade volume. Moreover, there is a marked contrast between the manufacturing and nonmanufacturing sectors: while production and exports continue to slow mainly in the manufacturing sector, the nonmanufacturing sector has been maintaining moderate expansion. It seems that the resilience in the nonmanufacturing sector, which accounts for a large share of the global economy, has been underpinning global economic growth. C. Recent Developments in Japan's Economy Next, I will talk about developments in Japan's economy. Japan's exports and production continue to show some weakness, mainly in the manufacturing sector, having been affected by the slowdown in overseas economies, particularly China (Chart 2). On the other hand, domestic demand has continued to expand moderately. Business fixed investment has continued to see firm growth, mainly in the nonmanufacturing sector, and private consumption has been increasing moderately, with the employment and income situation improving. Moreover, public investment has recently begun to expand. Developments in the economy from late 2018 show that firm domestic demand has continued to more than offset relatively weak external demand, and the real GDP growth rate registered positive growth for four consecutive quarters (Chart 3). The output gap has also remained positive. Given these developments, it can be assessed that a virtuous cycle from income to spending has continued to operate. Nonetheless, the effects on Japan's economy of developments in the global economy and of the October 2019 consumption tax hike need to be carefully examined for the time being. I will elaborate on recent developments in Japan's economy from two aspects, the demand side and the supply side. On the demand side, there is little prospect of a rapid recovery in exports, as the slowdown in overseas economies is expected to continue for the time being. Meanwhile, the moderate increase in domestic demand is likely to be sustainable, as private consumption, business fixed investment, public investment and other sectors have been resilient. Looking at developments by demand component, private consumption has continued to increase moderately, albeit with fluctuations mainly resulting from weather conditions. This increase has been supported by solid employee income reflecting the increased labor force participation particularly of women and seniors (Chart 4). As for business fixed investment, there has been an increase in not only software investment aimed at saving labor but also investment intended for domestic capacity expansion as well as research and development (R&D) investment with an eye toward future growth (Chart 5). This mainly reflects the fact that Japan's GDP has continued to grow at a pace above its potential, albeit moderately, and the need to meet rapidly increasing inbound demand. Looking at business fixed investment in detail by industry, the share of the nonmanufacturing sector has reached around 70 percent recently. There is some possibility that the adverse impact on Japan's business fixed investment of the slowdown in overseas economies will be limited, underpinned by business fixed investment related to resilient domestic demand. Turning to public investment, investments associated with disaster-related restoration and reconstruction as well as with national resilience have begun to increase and are expected to compensate for a peak-out of demand for construction related to the 2020 Tokyo Olympic Games (Chart 6). Next, I will turn to developments on the supply side. It is important that business fixed investment -- which has been expanding continuously -- positively affects not only demand but also supply, in terms of the enhancement of production capacity. Particularly in industries facing labor shortages, there has been active business fixed investment with the aim of improving labor productivity. This has been raising capital intensity, or capital per worker. While such active investment among some industries acts to induce price rises by raising the potential growth rate, the increase in productivity seems to have been acting as a factor constraining upward pressure on prices by easing upward pressure on wages. I will come back to this point later. D. Outlook for Japan's Economy With regard to the outlook for Japan's economy going forward, economic developments warrant cautious monitoring over the next six months or so, as the consumption tax hike conducted in October is expected to have an impact in the short term -- although its effects seem smaller than those of the previous hike in April 2014 -- and the transition of the global economy to a moderate recovery path is unlikely to take place until around mid-2020. Under these circumstances, the pace of Japan's moderate economic growth may decelerate in the short term. At the same time, however, such deceleration is unlikely to continue in the medium to long term. This is because, owing to the continuation of monetary easing over the past seven years, there has been significant improvement in the employment situation, prolonged labor shortages have encouraged firms to change their behavior, and a virtuous economic cycle has been operating by means of an increasing trend in business fixed investment. Moreover, with steady business fixed investment in the nonmanufacturing sector, which accounts for a large proportion of such investment, there has been a steady increase in the robustness of Japan's economy to external shock, namely the slowdown in overseas economies. For the time being, it is important to carefully examine developments in the global economy and their effects on Japan's economy. Nevertheless, we should not be overly pessimistic about the outlook. Given that the pace of decline in the working-age population (those aged 15-64) will continue to exceed that in the total population for the time being, labor market conditions are likely to remain tight. In this situation, expansion in business fixed investment -- particularly that intended to address labor shortages -- and firm private consumption are highly likely to be sustained (Chart 7). According to the Outlook for Economic Activity and Prices released by the Bank of Japan in October 2019, the medians of the Policy Board members' forecasts for the real GDP growth rate are 0.6 percent for fiscal 2019, 0.7 percent for fiscal 2020, and 1.0 percent for fiscal 2021 (Chart 8). II. Prices A. Recent Price Developments and Their Background Next, I will turn to price developments. The year-on-year rate of increase in Japan's consumer price index (CPI) for all items less fresh food has continued to rise moderately within the range of 0.0-0.5 percent (Chart 9). The year-on-year increase has been in positive territory for three years, affirming the improved robustness of the economy to the possibility of falling back into deflation. However, we have not yet reached a situation where the inflation rate is further accelerating and approaching close to the 2 percent price stability target. Gradual changes in Japan's inflation mechanism in recent years may account for this situation, in which the economy is no longer in deflation but is not seeing an acceleration in inflation. Three factors in Japan's current inflation mechanism are relevant in this context: one factor is exerting upward pressure on prices, namely, the continuing positive output gap; while the other two factors are constraining inflation, specifically, the persistent deflationary mindset of the public and improvements in labor productivity. First, the output gap -- the factor exerting upward pressure on prices -- has remained consistently positive since the October-December quarter of 2016. In fact, the inflation rate and the output gap have been running in parallel with each other, with a certain time lag. This correlation indicates that the positive output gap has been acting as a factor placing upward pressure on prices. Let me turn to the two factors constraining inflation. As for the first factor -- namely, the persistent deflationary mindset -- this cost-saving mentality has become deeply entrenched among consumers due to their experience of prolonged deflation, and has been influencing the cautious price-setting stance of Japanese firms. In the formation of inflation expectations, the backward-looking expectation that reflects past inflation rates -- that is, the adaptive formation mechanism -- is more prominent in Japan than the forward-looking expectation that reflects future economic conditions and changes in policy measures. This accounts for the persistent deflationary mindset. Another factor constraining inflation relates to improvements in labor productivity, effects of which have been observed since around 2017. While the labor market is close to full employment, upward pressure on wages has not particularly increased. This is partly due to the fact that there was room for restraining wage increases as the labor force participation rate rose in parallel with the intensification of labor shortages; moreover, it is worth noting that, with the anticipation of longstanding labor shortages, firms embarked on labor-saving investments, which in turn resulted in improvements in labor productivity. From the viewpoint of the output gap, a further widening of the gap within positive territory has been avoided by reducing labor input. Improvements in labor productivity have prevented firms from passing increased costs, such as personnel expenses and raw material costs, on to sales prices (Chart 10). In other words, improvements in labor productivity have constrained inflation through the expansion in business fixed investment. B. Outlook As the inflation mechanism has become more complex, it is not easy to forecast the outlook for prices. First, a positive inflation rate is necessary to overcome the persistent deflationary mindset grounded in the adaptive formation mechanism. Assuming that the output gap remains positive, the key will be predicting the outlook for the remaining factor -- namely, the constraining effects on inflation due to improvements in labor productivity. The rise in labor productivity promoting changes in the economic structure should be taken into account when considering the outlook. That is to say, changes on the supply side not only act as a factor constraining inflation but also raise the growth potential of the economy. With heightened uncertainty over the outlook for the global economy, the immediate challenge for Japan's economy is to sustain the positive output gap and prevent any halt to the changes in the economic structure that have begun to progress, by maintaining moderate growth supported by steady domestic demand. If these immediate challenges are met appropriately, we should anticipate -- while keeping the economy free of deflation -- a moderate acceleration in the inflation rate when the labor force participation rate eventually stops rising and encourages real wage increases to catch up with the pace of growth in productivity. Risks to the outlook for prices also warrant vigilance. If the slowdown in overseas economies continues for longer than anticipated, and the output gap reverses back into negative territory, Japan's economy may face deflation again. As for now, given that the positive output gap is being maintained on the back of steady domestic demand, the Bank should spare no effort in preparing for circumstances where additional policy actions may be necessary, while carefully examining future economic developments both at home and abroad. In order to maintain the inflation momentum, it is important to be fully prepared for the global economy to recover. III. Monetary Policy A. Current Monetary Easing Policy and Its Basic Framework The basic framework for the Bank's current monetary easing policy introduced in September 2016 is Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control. Under this framework, with the aim of achieving the price stability target under yield curve control -- in which short- and long-term interest rates are controlled -- the Bank sets the shortterm policy interest rate at minus 0.1 percent and the target level for 10-year Japanese government bond (JGB) yields at around 0 percent. It also purchases JGBs to facilitate the formation of these interest rates consistent with yield curve control. Subsequently, in July 2018, the Bank introduced forward guidance, and in April 2019, decided on a set of policy measures, including expanding eligible collateral for its provision of credit, to enhance the sustainability of the monetary easing policy. Furthermore, at the most recent Monetary Policy Meeting held in October 2019, the Bank revised its forward guidance with a view to clarifying the need to continue examining the momentum toward achieving the price stability target. Alongside the implementation of these policy measures, the Bank continues with large-scale monetary easing. In carrying out its policy, I believe it is essential for the Bank to be committed to continuing with monetary easing by examining matters from a broad perspective, including developments in financial markets and the financial system as well as economic activity and prices, while carefully considering the balance between the positive effects and the side effects of continuing monetary easing. B. Future Conduct of Monetary Policy The Bank is committed to continuing with the current powerful monetary easing. Let me raise the following as points requiring particular attention in the future conduct of monetary policy: (1) the effects on Japan's economy of the slowdown in the global economy; (2) the balance between the positive effects and the side effects of continuing monetary easing; and (3) the conduct of monetary policy amid changes in the economic structure and in the inflation mechanism. The first point warrants considerable attention currently in predicting the outlook for Japan's economic activity. If overseas economies slow further and negative effects on Japan's economic activity materialize, it may become necessary to take policy actions. In this case, it will be important that such actions should be decided after examining the scale of the negative effects and how fast they spread. For example, if the economy faces a crisis, such as that which could threaten the financial system during the global financial crisis, this will lead to a rapid economic downturn through credit contraction. Therefore, decisive actions would be necessary. On the other hand, if the slowdown in overseas economies stemming from trade issues remains moderate, the speed with which it spreads to Japan's economy will also be moderate. Thus, there will be room to take policy actions after carefully examining developments in economic indicators. The issue of side effects is another reason why policymakers should refrain from taking hasty policy actions in the conduct of future monetary policy. Regarding the second point, namely the balance between the positive effects and the side effects of continuing monetary easing, it is becoming increasingly necessary to pay attention to the side effects on the financial system of continuing with the low interest rate policy. With limited demand for funds among firms, financial institutions' lending margins have been narrowing due mainly to the prolonged low interest rate environment (Chart 11). These institutions are increasing their amount of risk-taking in order to acquire profits. However, due to globally accommodative financial conditions, the number of borrowers or entities in which financial institutions can invest to secure profits commensurate with their risk-taking is limited, and the possibility is increasing that risks will materialize and financial institutions' capital adequacy ratios plunge in the event of an economic downturn. At the moment, the capital adequacy ratios of all types of financial institutions in Japan appear to be sufficient relative to the levels of regulatory requirements. Nevertheless, as the ratios have been on a declining trend, mainly those of regional financial institutions, it is becoming necessary to monitor more closely with the continuation of monetary easing. The Bank will examine risks in the financial system through various means, such as the Financial System Report, as well as on-site examinations and off-site monitoring, and when necessary, encourage financial institutions to address these risks. It will also open dialogue with a wide range of relevant parties, including the Bank's Center for Advanced Financial Technology, to help resolve the challenges facing financial institutions. As for the conduct of monetary policy, it is important for the Bank to make policy decisions in an appropriate manner while carefully examining the side effects of policy measures on the financial system. Lastly, as for the third point, the relationship between monetary policy and prices is no longer straightforward, as seen, for example, in an improvement in labor productivity accompanying labor-saving investment constraining inflation. As a result, uncertainty in this context is likely to remain high. In what follows, I would like to provide a somewhat detailed explanation of such changes in the economic structure and appropriate monetary policy in response to these changes. IV. Structural Changes in Japan's Economy and the Role of Monetary Policy I will now describe the structural changes in Japan's economy and the points that have recently come to require attention. Supported by a policy mix of monetary and fiscal policies that has been sustained over the past seven years, there have been slow but steady structural changes in the economy. These can be largely divided into changes in the industrial structure accompanying globalization, and the establishment of a virtuous cycle stemming from longstanding shortages of labor. These have resulted in other changes in Japan, such as the increased expectation of a rise in the economy's growth potential owing to the expansion of supply capacity, and an increase in the robustness of the economy to changes in the external environment. I will touch on each of these points in order, and then explain how monetary policy should be conducted in response to these structural changes. A. Changes in the Industrial Structure Accompanying Globalization Japanese manufacturers have been expanding their businesses in overseas markets since the beginning of the globalization trend that has lasted for over four decades following the collapse of the Bretton Woods system. Consequently, the share of the nonmanufacturing sector in Japan's GDP, which is a measure of overall domestic production, accounts for about 80 percent. Japan's outward direct investment has expanded rapidly with significant adjustments in foreign exchange rates since the latter half of the 1980s, leading to the establishment of current global supply chains. Reflecting the structural change of manufacturers' shifting their production sites overseas, the contribution of income generated through outward direct investment and outward portfolio investment, which is the fruit of firms' outward investment, has tended to increase in Japan's current account (Chart 12). At present, Japan's current account surplus accounts for approximately 4 percent of nominal GDP, and this consists mostly of gains from outward direct investment and outward portfolio investment. Japan's nominal gross national income (GNI) -- which is a measure of the nation's nominal GDP plus net income from overseas sources -- is about 4 percent larger than GDP, showing that Japan's economic structure has steadily changed to one in which manufacturers make profits from production overseas. B. Virtuous Cycle of the Economy amid Longstanding Shortages of Labor Let me now turn to structural changes in Japan's economy. Since around 2017, amid longstanding shortages of labor, some distinctive developments continue to be observed, such as moderate growth of the economy, the positive output gap, non-deflationary price rises, and an increase in business fixed investment. This suggests that the simultaneous progress of these interacting developments has contributed to the sustained operation of a virtuous cycle in Japan's economy. The positive output gap has been maintained as labor shortages continue amid a growing elderly population and a declining working-age population, coupled with the expansion of demand induced by monetary and fiscal policies. This seems to have raised the corporate sector's expectations that both the moderate expansion of the economy and labor shortages are likely to continue in the medium to long term. These raised expectations have led firms to the assessment that it would be possible to secure the cost-effectiveness of their investments, including long-term investments, as the positive business environment would be maintained to a certain extent. As a result, fixed investment has expanded, particularly investment aimed at saving labor. C. Expectations for a Rise in Potential Growth Rate Accompanying the Expansion of Supply Capacity Business fixed investment is one of the components that make up a nation's GDP. In addition to short-term demand, it expands supply by increasing production capacity and improving productivity in the medium to long term. As supply capacity has expanded in Japan along with the structural change of a continuous expansion of business fixed investment, there is the possibility that a moderate increase in the potential growth rate will be induced hereafter, with some time lag. Looking at recent developments in the potential growth rate, while the contribution of labor input has been decreasing, that of capital stock and total factor productivity (TFP) has started to bottom out (Chart 13). The expansion of business fixed investment, which has continued for the past three years, is starting to induce a supply-side structural change. Together with an increase in R&D investment with an eye toward promoting innovation, if the potential growth rate rises in the future -- in which case the natural rate of interest will also rise, causing real interest rates to fall below the natural rate of interest -- the same level of policy rate will have a greater easing effect. D. Increased Robustness to Changes in External Demand Another structural change I should point to is the increased robustness of the economy to changes in external demand. Given the established global supply chains, Japanese manufacturers have divided their production at home and abroad as follows: (1) overseas sites producing for their own local market and for export to third countries, and (2) Japanese sites producing for Japan's domestic market. This division has likely resulted in a mitigated adverse effect that a slowdown in external demand would have on Japan's GDP through a decrease in exports. Given the geopolitical background to the U.S.-China trade conflict, it is entirely possible, depending on future developments, that existing global supply chains may be reorganized, particularly with respect to China. Nonetheless, I expect that such reorganization will not greatly affect the decision making of Japanese firms regarding where to establish their production sites -- whether in Japan or abroad, whether for export or for local production. This is because the division of work among production sites at home and abroad has already been established to a certain extent, and it is difficult to imagine any significant decline in domestic business fixed investment, even if overseas production were relocated to a different country. Moreover, it is highly likely that domestic business fixed investment will continue to expand in light of other structural changes, such as firm investment by the nonmanufacturing sector and labor shortages that are expected to continue in the medium to long term. E. Monetary Policy Supporting Structural Changes in Japan's Economy The fundamental role of monetary policy is to achieve price stability, thereby realizing and maintaining a sound macroeconomic environment. The Bank's monetary policy itself does not have a direct impact in terms of altering Japan's economic structure. However, as the large-scale monetary easing policy has been in place for almost seven years, many indicators suggest that Japan's economy has improved, and prices are no longer in deflation. Even since the start of this year, solid domestic demand has supported a continued moderate expansion, despite the economy being affected somewhat by the slowdown in the global economy caused by the intensified U.S.-China trade conflict. Increased robustness to changes in external demand has helped sustain Japan's moderate economic growth, even in the face of a continuing slowdown in the global economy. As favorable economic conditions have been maintained, structural changes in the economy have brought about this increased robustness. In other words, being committed to continuing with large-scale monetary easing policy has led to improvements in economic activity, thereby indirectly supporting the structural changes in the economy. Moreover, the current monetary easing policy has been effective owing partly to the stability of the whole macroeconomic policy framework. The government and the Bank have clearly shared a basic understanding of the policy mandate and the division of their roles in conducting the monetary and fiscal policy mix. While monetary policy aims to directly stabilize the economy, fiscal policy aims not only to stimulate the economy as a whole but also to implement a structural policy through such channels as budgetary allocations. It seems evident that both the stabilization of the economy in recent years and the smooth structural changes that have occurred can be attributed to this mix of monetary and fiscal policies, grounded in macroeconomic policy. Furthermore, it is also important to note from a global perspective that Japan's economy has been generally stable in recent years. At present, there are no large differences in the levels of price targets among major advanced countries, and since the start of the year their monetary policies have tended to be more or less accommodative. Also, as a decade has passed since the global financial crisis, the balance between the size of the central bank's balance sheet and the money supply in each of the major advanced countries has been quite stable (Chart 14). In other words, this could be seen as an indication that the difference in the levels of quantitative easing in major countries has declined. In addition, as Japan's economy continues to be no longer in deflation, there has been a significant decline in the difference between major countries' inflation rates -- which affects the long-term nominal exchange rate in light of purchasing power parity (PPP) (Chart 15). Under these circumstances, financial markets may fluctuate in the short term in reaction to news reports, but in the long run appear to move only within a certain range. This suggests that the similarity of global monetary policies in major countries is constraining market fluctuations, thereby contributing -- together with the increased robustness of the economy to changes in external demand -- to the stabilization of Japan's economy. Japan's accommodative monetary policy supports structural changes in the economy by sustaining a policy mix with fiscal policy, and through the similarity of global monetary policies. It also functions as an anchor that constrains fluctuations in financial markets. Among the concerns that have emerged in light of the U.S.-China trade conflict, there are worries regarding frameworks of international cooperation, which have come under considerable strain. The outlook for global trade issues is a matter for concern. Nevertheless, while Japan's policy mix and global accommodative financial conditions are maintained, I consider the important policy issue for Japan is to sustain the positive output gap and support the changes to the economic structure that have begun by appropriately addressing the slowdown in the global economy and waiting patiently for its recovery. Thank you for your attention. Economic Activity, Prices, and Monetary Policy in Japan ── Speech at a Meeting with Business Leaders in Hyogo ── November 27, 2019 Makoto Sakurai Member of the Policy Board Bank of Japan Chart 1 Global Economy IMF growth projections (as of October 2019) World trade volume real GDP growth rate, y/y % chg., % points 2017 2018 World Advanced economies United States Euro area Japan Emerging market and developing economies China ASEAN 5 3.8 3.6 2.5 2.3 2.4 2.9 2.5 1.9 4.8 6.8 5.3 1.9 0.8 4.5 6.6 5.2 projection projection 3.0 （‐0.2） 1.7 （‐0.2） 2.4 （‐0.2） 1.2 （‐0.1） 0.9 （0.0） 3.9 （‐0.2） 6.1 （‐0.1） 4.8 （‐0.2） 3.4 （‐0.1） 1.7 （0.0） 2.1 （+0.2） 1.4 （‐0.2） 0.5 （+0.1） 4.6 （‐0.1） 5.8 （‐0.2） 4.9 （‐0.2） y/y % chg. Emerging economies Advanced economies World ‐1 ‐2 CY 201 2 Notes: 1. In the left-hand chart, figures in parentheses are the difference from the July 2019 projections. 2. In the right-hand chart, figures are those for real imports. The figure for 2019/Q3 is the July-August average. Sources: IMF; CPB Netherlands Bureau for Economic Policy Analysis, etc. Chart 2 Japan's Real Exports Advanced economies Emerging economies s.a., 2013/Q1 = 100 s.a., 2013/Q1 = 100 China <19.5> United States <19.0> EU <11.3> Other economies <14.8> CY20 1 3 NIEs, ASEAN, etc. <35.4> CY20 1 3 Notes: 1. Based on staff calculations. 2. Figures in angle brackets show the share of each country or region in Japan's total exports in 2018. Sources: Ministry of Finance; Bank of Japan. Chart 3 Growth Rate and Output Gap Real GDP Output gap contribution ratio, s.a., ann., q/q % chg. % reversed, DI ("excessive" ‐ "insufficient"), % points Capital input gap (left scale) Labor input gap (left scale) ‐40 ‐30 Output gap (left scale) Tankan factor utilization index (right scale) ‐20 Private demand -5 Public demand ‐10 ‐2 ‐4 ‐6 ‐8 CY20 07 08 09 10 11 12 13 14 15 16 17 18 19 Net exports -10 -15 CY20 1 1 Real GDP Notes: 1. In the right-hand chart, the output gap is based on staff estimates. 2. The Tankan factor utilization index is calculated as the weighted average of the production capacity DI and the employment conditions DI for all enterprises. The capital and labor shares are used as weights. Sources: Cabinet Office; Bank of Japan. Chart 4 Employment and Income Situation Labor market conditions 2.0 s.a., ratio s.a., % Employee income y/y % chg. 1.5 1.0 0.5 Active job openings-to-applicants ratio (left scale) Unemployment rate (right scale) 0.0 CY20 08 Total cash earnings Number of employees Employee income -2 CY20 12 Notes: 1. Each quarter in the right-hand chart is as follows: Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. 2. Employee income = total cash earnings ("Monthly Labour Survey") × number of employees ("Labour Force Survey"). Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 5 Investment Software investment (Tankan) Business fixed investment by industry FY 2011 = 100 All industries sum of the latest 4 quarters, tril. yen Construction Retailing Accommodations, eating and drinking services Manufacturing Nonmanufacturing All industries FY20 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 CY20 1 2 Notes: 1. In the left-hand chart, figures up through fiscal 2018 are actual results. Figures for fiscal 2019 are forecasts from the September 2019 survey. 2. In the right-hand chart, figures include software investment. Sources: Bank of Japan; Ministry of Finance. Chart 6 Investment (continued) Developments in business fixed investment plans Public investment sum of the latest 12 months, tril. yen Public investment contracted Public investment completed CY20 11 Notes: 1. In the right-hand chart, figures are based on the Tankan. All industries, including financial institutions. 2. Including software and research and development (R&D) investment and excluding land purchasing expenses (R&D investment is not included until the December 2016 survey). Sources: Bank of Japan; Ministry of Land, Infrastructure, Transport and Tourism; East Japan Construction Surety Company, Ltd. Chart 7 Population Change by Age Group ann. chg., 5-year moving avg., 10 thous. persons Total Aged 15-64 Aged 0-14, 65- Estimation -20 -40 -60 -80 -100 CY 2000 Note: As of October 1 for all years. Figures for 2019 are estimates, and those from 2020 onward are calculated using mediumfertility and medium-mortality assumptions presented in the population projections released by the National Institute of Population and Social Security Research (IPSS). Sources: Ministry of Internal Affairs and Communications; IPSS. Chart 8 Outlook for Economic Activity and Prices as of October 2019 Forecasts of the Policy Board Members y/y % chg. FY 2019 Forecasts made in July 2019 FY 2020 Forecasts made in July 2019 FY 2021 Forecasts made in July 2019 Real ＧＤＰ CPI (all items less fresh food) ＋0.6 ＋0.7 ＋0.7 ＋1.0 ＋0.7 ＋1.1 ＋0.9 ＋1.3 ＋1.0 ＋1.5 ＋1.1 ＋1.6 Notes: 1. Figures indicate the medians of the Policy Board members' forecasts (point estimates). 2. CPI forecasts incorporate the expected effects of the October 2019 consumption tax hike and policies concerning the provision of free education. Source: Bank of Japan. Chart 9 CPI 2.0 y/y % chg. 1.5 1.0 0.5 0.0 -0.5 -1.0 CPI (all items less fresh food) -1.5 -2.0 CY20 1 1 CPI (all items less fresh food and energy) Note: Figures are adjusted for changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 10 Real Wage Gap s.a., average from CY 1980 onward = 100 % Real wage gap (right scale) Real wages (left scale) Labor productivity (left scale) -10 CY1985 Notes: 1. Real wages = personnel expenses / number of workers / GDP deflator 2. Labor productivity = (operating profits + personnel expenses + depreciation expenses) / number of workers / GDP deflator 3. Variables such as personnel expenses are based on the "Financial Statements Statistics of Corporations by Industry, Quarterly" and exclude "finance and insurance." 4. Figures from 2009/Q2 exclude "pure holding companies." Sources: Ministry of Finance; Cabinet Office. Chart 11 Corporate Funding Deposit-lending margins and excess savings by firms % tril. yen % Share of debt-free firms % Debt-free firms (left scale) De facto debt-free firms (right scale) Saving-investment balance by firms (right scale) Domestic deposit-lending margin (left scale) Excess savings Excess investment -1 FY1980 -50 FY20 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Notes: 1. In the left-hand chart, "savings-investment balance by firms" covers private nonfinancial corporations. "Domestic deposit-lending margins" covers regional banks. 2. In the right-hand chart, "debt-free firms" is defined as firms without borrowings. "De facto debt-free firms" is defined as firms whose cash and deposits exceed their total amount of borrowings. Sources: Bank of Japan; Teikoku Databank. Chart 12 External Demand-Driven Growth and Outward Investment Current account tril. yen GNI sum of the latest 4 quarters, tril. yen Net income (left scale) GDP (left scale) GNI (left scale) Net income/GDP (right scale) ‐10 % Portfolio investment income Direct investment income Trade balance Others Current account ‐20 CY20 00 02 04 06 08 10 12 14 16 18 Note: In the right-hand chart, GDP and GNI are nominal. Sources: Cabinet Office; Ministry of Finance; Bank of Japan. CY 1995 Chart 13 y/y % chg. Potential Growth Rate 2.0 1.5 Total factor productivity Capital stock Labor input Potential growth rate 1.0 0.5 0.0 -0.5 -1.0 -1.5 FY20 00 Note: Based on staff estimates. The figure for the first half of 2019 is that for 2019/Q2. Source: Bank of Japan. Chart 14 Monetary Policy Similarities Central bank balance sheets End 2007 = 100 Relative change in balance sheets FRB ECB BOJ difference in y/y, % points reversed, JPY FRB - BOJ (left scale) USD/JPY (right scale) USD depreciation Fed's balance sheet relatively expanded BOJ's Comprehensive Assessment CY 2008 -50 CY 2008 09 10 11 12 13 14 15 16 17 18 19 Notes: 1. In the left-hand chart, figures represent total assets. 2. The red line in the right-hand chart shows the year-on-year difference in the gap in balance sheet size between the FRB and the Bank of Japan. Sources: FRB; ECB; Bank of Japan; Bloomberg. Chart 15 Developments in Inflation Rates 3.5 ann. avg., y/y % chg., 5-year moving avg. 3.0 3.5 difference in y/y, % points 3.0 2.5 yen appreciation pressure 2.5 2.0 2.0 1.5 Japan 1.5 United States 1.0 Euro area 1.0 0.5 United States - Japan 0.0 0.5 Euro area - Japan -0.5 CY 2008 0.0 CY 2008 Notes: 1. Japan's inflation rate incorporates the effects of the October 2019 consumption tax hike. Those of the United States and euro area are based on the IMF's World Economic Outlook. 2. The right-hand chart shows the gap in inflation rates between the United States and Japan, and between the euro area and Japan. Sources: Ministry of Internal Affairs and Communications; IMF.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Asia Pacific Initiative Forum, Yokohama, 8 December 2019.
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December 8, 2019 Bank of Japan A Perspective on the Future of Asia Remarks at the Asia Pacific Initiative Forum in Yokohama Haruhiko Kuroda Governor of the Bank of Japan Introduction Good morning Ladies and Gentlemen. It is my great pleasure to join you today at the inaugural meeting of the Asia Pacific Initiative Forum. I am confident that this forum will develop into a central platform where Asian business leaders and policy makers can gather to share insights, forge new partnerships and develop new innovative ideas to tackle global as well as intraregional challenges. Today, I would like to touch upon some characteristics and future challenges for Asia from a macro perspective. My speech will be based on my experience serving as Vice Minister for International Affairs at the Ministry of Finance in Japan, President of the Asian Development Bank and Governor of the Bank of Japan. I. An Asian Century I would like to begin by first trying to put the word "Asia" into context. Looking into the etymology of "Asia," one explanation is that it comes from the Akkadian word asu, which means "to go out, to rise," in reference to the sun, thus "the land of the sunrise."1 So a couple of thousand years back, all people or cultures originating from the east were collectively classified into a single category of "Asians" or "Asia." However, the actual diversity of ethnicity, religion and culture across Asia is immense compared with other regions of the world. For example, the number of Asian sovereign states that are members of the United Nations is 48, and there are more than 10 different official languages used in multiple sovereign states. There are also vast differences in the stage of development of Asian states, as the largest country in terms of per capita GDP on a purchasing power parity basis is more than 7 times as large as the smallest one in the region.2 While it is difficult to generalize about Asia, the expression "the Asian Century" is used quite frequently. The phrase expresses Asia's growing global presence, and is used similarly to terms such as the "Pacific" or the "Chinese" century, and also to terms such as the "East Asian miracle" or "Asia's rise." 1 Etymonline.com., "Asia – Origin and meaning of Asia by online Etymology Dictionary." Retrieved November 24, 2019. 2 U.S. Central Intelligence Agency, "The World Factbook," 2018. At the same time, the term "Asian Century" evokes a historical narrative of shifting centers of world power such as from Great Britain in the 19th century to the United States in the 20th century. Back in 1904, Halford Mackinder, an English geographer, academic and politician wrote "The Geographical Pivot of History," in which he forecast that the 20th century was going to be the Asian Century. His forecast turned out to be incorrect. However, many envision the 21st century as an Asian century, given the expansion of the Asian economy and the growth of its population. Kishore Mahbubani, a Singaporean academic and former diplomat has argued that the last two centuries of Western domination of world history have actually been an anomaly from history. In the period from A.D. 1 to 1820, the two largest economies of the world were those of China and India.3 More recent data on the economic presence of Asia is shown in Chart 1. II. Current State of Asia Before I proceed, let me briefly mention some recent facts regarding Asia. Asia has led global growth for the past several decades, and as of 2018, accounts for more than 40% of global GDP. 4 The region is home to around 60% of the world’s total population. The share of intraregional trade has been increasing and accounts for 58% of the total trade of all the region's countries. Financial interconnectedness is also deepening. These characteristics are shown in Chart 2. Regional policy cooperation is taking place through various platforms. ASEAN is the center of regional economic integration in South East Asia, and the scope of its cooperation has widened with the involvement of other countries to form ASEAN+3 and ASEAN+6, and even beyond Asia through arrangements such as APEC. Many Asian countries are members of G20 and their contribution to global policy making is increasing. In the area of central bank cooperation, regional forums such as EMEAP and SEACEN are enhancing the active exchange of views and the sharing of knowledge among members. The movement of people across borders is becoming much more active as regional integration deepens. This is also reflected, for example, in the regionalization of the media and popular 3 Schibotto, Emanuele, and Gabriele Giovannini, "Singapore's Role in the Asian Century – interview with Kishore Mahbubani," Asian Century Institute, February 12, 2015. 4 International Monetary Fund, "IMF Data Mapper, World Economic Outlook October 2019 (GDP)." culture. There is a long-established network of production, distribution and consumption of Chinese-language pop music, opera and films within the Chinese community all around Asia. In the 1990s, Japanese television dramas became a staple of audiences across East Asia. This success encouraged the Korean television industry to actively export its own dramas regionally. These developments have resulted in a loosely integrated regional media and cultural industry in East Asia which has also helped promote intra-Asian tourism and cultural exchange. III. Asia as Future With the increasing interconnectedness of the region and its growing economic presence, it is not surprising that there are expectations that Asia can and will lead the world. But simply extrapolating from the strong economic performance of recent decades can be misleading. As we well know, economic size alone is not enough to be accepted as a global leader. Looking back at history after World War II and how the major powers have evolved, it clearly shows that it is not just about brute economic or military power. A combination of vision, moral values and respect toward others are also essential. What do we have to do in Asia to truly harness the potential of this vast and complex region, so that Asia can play an active role at the global stage? Asian countries will need to work further to deepen intraregional collaboration based on mutual recognition and respect while acknowledging the diverse nature of this region. Specifically, further deepening of economic regional interconnectedness will certainly be necessary. Also, a broader perspective to increase joint engagement in the global community on non-economic issues will be important. I would like to touch upon them separately. Enhancing Regional Integration If Asia is to take on a global leadership role, this would require the promotion and maintenance of open and flexible economies and markets. The strengthening of Asian supply chains would also be essential for enhancement of economic interconnectedness. Much has already been achieved on economic integration. For example, in ASEAN, there has been progress in eliminating tariffs, advancing services liberalization, liberalizing and facilitating investment and facilitating skilled labor mobility. However, as shown in Chart 3, compared to Europe, Asia has a lower participation rate in global supply chains. Promoting trade liberalization through frameworks such as TPP11 and RCEP would be the way forward, especially in an environment where global trade tensions are high. It is important to promote trade not only in goods but also in services. The region is steadily transitioning from being mainly a production area of the world to the biggest corporate and consumer market in the world. This naturally increases the demand for services in the region as well. Equally important is coordination on cross-border regulatory and institutional elements within the region. Discussions in ASEAN's Economic Community Blueprint 20255 could provide hints on how to address such cross-border issues. For example, the business community has in the past raised issues regarding the differing requirements and regulations among ASEAN countries with incomplete mutual recognition agreements, and the burdensome processes and inadequate transparency in some member countries. Although substantial progress has been made, differences among members remain in terms of ease of doing business and trading across borders. These challenges are noted in other Asian countries as well. While the EU has been aiming for economic integration through the establishment of a single market, Asian countries, such as the members of ASEAN, have preferred to preserve each country's sovereignty. This is certainly appropriate, reflecting the region's diversity. Having said that, as regional economies become more dependent on each other, more work is necessary to reduce barriers to free trade of goods and services and for direct investment. This would boost intraregional demand as a source of growth. It is also essential to work jointly in developing deep and liquid financial markets to enhance the effective use of regional savings and to invite long-term capital inflows. As a basis for further strengthening such economic ties, it is also important to patiently strive to deepen fundamental mutual understanding among countries and people in the region. As I mentioned earlier, Asian countries are highly diverse not only in economic aspects such as income, industrial structure and technological progress, but also in many other fields such as religion and culture. For this reason, it is important to foster a stronger sense of trust while respecting each other's unique characteristics. 5 ASEAN's Economic Community (AEC) Blueprint 2025 enlists concrete actions to be taken by 2025 in order to realize the AEC envisaged in ASEAN's Community Vision 2025. Engaging with the Global Community Asia must also actively engage in global discussions beyond pure economic issues. For example, according to research by a consulting firm comparing the soft power of different countries, only four countries from Asia are in the top 30,6 as shown in Chart 4. With around 60% of the global population, Asia has a responsibility to play a constructive role in global issues such as climate change and inequality. Through effective dialogue, ideas and values originating in Asia could provide a positive impetus to the global debate. From this perspective, it is important to continue to actively participate in international discussions and to raise Asian voices through frameworks such as the G20. As I mentioned, climate change is an area that requires Asia's active contribution. Addressing climate change risk requires a global effort. But, as a region that would be greatly affected by increases in natural disasters, rising sea levels, and damage to agricultural and fishery industry, this is a much more urgent issue for Asia. At the same time, in step with economic growth, carbon dioxide emissions in Asia have increased rapidly, and counted for more than half of total global emissions in 2017.7 It is important to collaborate within the region and with the global community, by for example actively encouraging the introduction and sharing of environment-friendly technologies. How to take advantage of digital transformation is another area that Asia could play a leading role in the global discussion. Many Asian countries including China, India and Japan are key innovators and manufacturers of digital technology. If countries in the region can coordinate their digital supply chains, the synergies would be significant. From another perspective, most Asian countries face intractable demographic dilemmas. In much of East Asia, fertility has dropped below replacement rates, populations are aging, and workforces declining. Laborsaving technology can help mitigate this demographic challenge and should improve the productivity of East Asian countries. Conclusion Let me conclude. The globalization that led the development of the global economy after 6 Portland, "The Soft Power 30," 2019. 7 Global Carbon Project, "Global Carbon Budget 2018." World War II has slowed recently. Countries have become more inward oriented, and this change has become a major headwind for cross-border financial and economic activities. On the other hand, multilateral efforts are indispensable in tackling many issues ranging from trade to climate change. Asia is one of the regions that has benefited most from post-war financial and economic globalization. In this age of uncertainty, the search for a new "global order" continues. This brings both challenges and opportunities for the Asian region, and expectations for the region to contribute to the global debate are high. To that end, it is important for Asia to promote further intraregional collaboration based on mutual understanding and respect. Strengthening the bond within Asia will enable the region to contribute to solving global issues. Based on my many years of working with colleagues in Asia, I am confident that the Asian Century will certainly come. Thank you for your kind attention.
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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, Oita, 5 December 2019.
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December 5, 2019 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Oita Yutaka Harada Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with you and for having taken the time to be here despite your 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 business operations of the Bank of Japan, particularly of the Oita Branch. The Bank has implemented quantitative and qualitative monetary easing -- or QQE for short -- since April 2013 and introduced various additional measures such as the negative interest rate policy, yield curve control, strengthening the framework for continuous monetary easing, and clarification of forward guidance for policy rates, all with the aim of achieving the inflation target of 2 percent. As a result of these measures, Japan's economy has been improving. It is true that the economic expansion has not exactly been robust, reflecting such events as the consumption tax hike in fiscal 2014 from 5 percent to 8 percent, the latest hike in October 2019 from 8 percent to 10 percent, the slowdown in the global economy observed from mid-2015 through early 2016 and from the second half of 2018 to the present, and the downtrend in the working-age population. Nevertheless, the economy has managed to continue its expansion so far. Today, I would like to explain monetary policy measures conducted by the Bank and what they have achieved. First and foremost, the achievements are obvious. The unemployment rate has declined to its lowest level in nearly three decades and productivity has been increasing. The challenge lies elsewhere; namely, in the fact that prices have not been rising. It is increasingly being argued that interest rates consequently have remained low, eroding banks' profitability. However, I believe that the deterioration in banks' profitability is caused by the structural problem that banks are accumulating more deposits than they can lend. Banks therefore need to deal with this problem. Moreover, if interest rates were raised, this would lead to a decrease in the demand for loans, a decline in prices, an appreciation of the yen, an economic downturn, an increase in bankruptcies (raising banks' credit costs), and so forth. Therefore, raising interest rates would not solve the problem. Considering that the current low interest rates are partly attributable to the deflationary monetary policies pursued in the past, as I will describe later, the only way out is to maintain the current accommodative monetary policy in order to achieve sustained expansion of economic activity until we see increases in prices and interest rates. I. Monetary Easing Measures Table 1 presents an outline of the monetary policy measures conducted by the Bank since April 2013, when it introduced bold monetary policy. Table 1 Timeline of the Bank's Monetary Policy Measures Jan 13 Apr 13 Oct 14 Jan 16 Jul 16 Sep 16 Jul 18 Apr 19 Oct 19 Introduction of the "price stability target" of 2 percent Introduction of QQE - Monetary base: increase at an annual pace of about 60 to 70 trillion yen - Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 50 trillion yen Expansion of QQE - Monetary base: increase at an annual pace of about 80 trillion yen - Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 80 trillion yen Introduction of "QQE with a Negative Interest Rate" - A negative interest rate of minus 0.1 percent is applied to the Policy-Rate Balances in current accounts held by financial institutions at the Bank. "Enhancement of Monetary Easing" - Amount outstanding of the Bank's ETF holdings: increase at an annual pace of about 6 trillion yen Introduction of "QQE with Yield Curve Control" - Yield curve control The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent). With regard to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace. - Inflation-overshooting commitment "Strengthening the Framework for Continuous Powerful Monetary Easing" - Introduction of forward guidance for policy rates The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019. - Yield curve control The yields may move upward and downward to some extent mainly depending on developments in economic activity and prices. With regard to the amount of JGBs to be purchased, the Bank will conduct purchases in a flexible manner so that their amount outstanding will increase at an annual pace of about 80 trillion yen. Clarification of forward guidance for policy rates The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike. Introduction of new forward guidance for policy rates As for the policy rates, the Bank expects short- and long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. As a result of these measures, real interest rates -- nominal interest rates minus expected inflation rates -- have greatly declined due to the decrease in nominal interest rates and the rise in inflation expectations. The decline in real interest rates has stimulated investment, boosted stock prices in Japan, and led to a depreciation of the yen. Rising stock prices further raise investment and lead households that have become wealthier to increase their consumption expenditure. It is through these channels that economic activity started to improve. Next, I would like to explain my stance on the new forward guidance introduced in October 2019, which is shown in Table 1. The forward guidance in April 2019 stated that the Bank "intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020." While I thought that clarifying the forward guidance was desirable, I opposed the policy proposal on the basis that the Bank should indicate data-dependent guidance to further clarify its link with the price stability target.1 Under the new guidance, the Bank "expects short- and long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost." Although it is somewhat ambiguous, I voted for this proposal because the guidance became more akin to data-dependent guidance, in which the link to the price stability target is clearer, and allowed for the possibility of a future interest rate reduction. However, I continued to oppose allowing long-term yields to move in a more flexible manner. Since I already have elaborated on my reasons for this in the past, let me move on to the next topic.2 II. Achievements of Bold Monetary Easing Improvement in economic activity can be seen in various fields. There are a lot of indicators that show improvement, such as employment, productivity, fiscal conditions, investment, exports, corporate profits, and wages; moreover, perceptions that the economy is recovering, For my opinion regarding data-dependent forward guidance, see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Yamanashi," Bank of Japan, March 2019. 2 See the reference cited in footnote 1. the suicide rate, the income distribution, and women's entry into the labor market provide further indications of improvement.3 Of these indicators, I would like to talk today about the improvements in employment, productivity, and fiscal conditions. Improvement in Employment The improvement in employment is clear from the rise in the active job openings-to-applicants ratio, the decline in the unemployment rate, the increase in the number of employees, and other indicators. The increase in the number of employees is due to the rise in the employment rates of women and the elderly in particular. While there remains the issue that many of the women and the elderly are not regular but non-regular employees and only work short hours, the situation certainly is an improvement from the past. In an aging society, the fact that the employment rate of the elderly actually has risen holds great importance. The problem with an aging population is that the number of people who cannot work because of old age is increasing relative to the number of working-age people. It is worrying that it seems the ratio of the elderly (those aged 65 and over) to the working-age population (those aged 15-64) will rise from 47 percent in 2018 to 70 percent in 2045 (and then further rise moderately to 75 percent in 2065). However, if we assume that the working-age population comprises those aged 15-69 and the elderly population consists of those aged 70 and over, the ratio of the elderly to the working-age population will reach only 49 percent in 2045 and 55 percent in 2065. Looked at this way, the increase in the employment rate of the elderly brought about by monetary easing can be regarded as good news for Japan's aging society. Next, I would like to look at the employment situation, focusing on the employment environment for the young. Chart 1 shows the unemployment rate, the youth unemployment rate, and the job offer rates for university students as of October and December of the year before they graduate and as of February and April of the year of graduation. 4,5 As Regarding improvements in these indicators, also see Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Fukushima," Bank of Japan, November 2017, and Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Yamanashi," Bank of Japan, March 2019. 4 The job offer rate is the ratio of students who have received job offers among applicants. 5 The academic term in Japan starts in April and ends in March. mentioned earlier, the overall unemployment rate has declined almost consistently, marking 2.4 percent in October 2019. While the youth unemployment rate usually is higher and tends to be more volatile than the overall unemployment rate, this also has been declining steadily. In addition, the job offer rates for the respective months have registered record highs. While figures for the job offer rates are only available from 1997, the rates must have been high during the bubble period and lower after the burst of the bubble, given that they are negatively correlated with the youth unemployment rate. The shaded areas in the chart represent the so-called "employment ice age."6 If the unemployment rate had been lowered through monetary policy, there might not have been such an employment ice age, or at least it might have been mitigated. Chart 1 Unemployment Rates and Job Offer Rates % 100 11 % CY1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 Unemployment rate Youth unemployment rate (15-24 years old) Job offer rate (October, right scale) Job offer rate (December, right scale) Job offer rate (February, right scale) Job offer rate (April, right scale) Notes: 1. Job offer rates are for university students that are expected to graduate. 2. Figures for job offer rates (February, right scale) for 1997, 1998, and 1999 are those for March. 3. The shaded areas represent the so-called "employment ice age." Source: Ministry of Education, Culture, Sports, Science and Technology and Ministry of Health, Labour and Welfare, "Daigaku, tanki daigaku, kōtō senmon gakkō oyobi senshū gakkō sotsugyō yoteisha no shūshoku naitei jōkyō chōsa." Per its support plan for the employment ice age generation, released on May 29, 2019, the Ministry of Health, Labour and Welfare defined people who graduated from university from around 1993 to 2004 as the "employment ice age generation." The period of a few years from the outbreak of the global financial crisis in 2008 is also regarded as a reemergence of the employment ice age, according to the following report. Genda Yuji et al., Shūshoku hyōgaki sedai no keizai, shakai e no eikyō to taisaku ni kansuru kenkyū iinkai hōkokusho (Tokyo: Japanese Trade Union Confederation Research Institute for Advancement of Living Standards, November 2016). Regarding the impacts of the employment ice age, see Saeko Maeda et al., "How does the first job at graduation matter for female workers in Japan?" ESRI Discussion Paper Series, no. 234, March 2010. The Bank started QQE in April 2013, but if it had been introduced earlier, the unemployment rate in Japan without doubt would have remained in the range of 2.0-3.0 percent throughout. Since the unemployment rate from the mid-1990s to 2012 on average was roughly 4.5 percent, the current unemployment rate of 2.4 percent means that the unemployment rate has almost halved. This decline in the unemployment rate also has helped to raise productivity, which I will touch on next. Productivity Growth Productivity also has been rising in tandem with the improvement in employment. Since I have talked about this in the past, here I only would like to note that it has been rising. 7 Let me just briefly summarize the reason behind this occurrence. When an economy is in recession, firms curtail investment in physical assets, human resources, and research and development. Young people caught up in the employment ice age missed out on on-the-job training opportunities. Although it is impossible to make up all the lost ground, some of it can be slowly gained over time, helping to gradually raise the productivity of the economy. Improvement in Fiscal Conditions Bold monetary easing has stimulated economic activity, increased tax revenues, and improved fiscal conditions. Chart 2 presents the ratios relative to nominal GDP of the general government fiscal balance, gross government debt outstanding, and net government debt outstanding. The GDP ratio of the general government deficit has decreased by 5.6 percentage points from 8.3 percent in fiscal 2012 to 2.7 percent in fiscal 2017, and the GDP ratio of net government debt, which had been increasing sharply, is more or less unchanged at around 121 percent since fiscal 2012.8 See Harada Yutaka, "Nihon keizai to seisansei: Special Lecture at a Conference Commemorating Daiwa Institute of Research's 200th Release of Japan's Economic Outlook," Bank of Japan, March 2019. 8 Of the improvement in the GDP ratio of the general government fiscal balance of 5.6 percentage points, 1.5 percentage points were brought about by the consumption tax hike from 5 percent to 8 percent. Let me explain the importance of net government debt.9 Net government debt is calculated by subtracting government financial assets from gross government debt. It used to be argued that, although Japan's gross government debt was substantial, this was not a problem because net government debt was not that large. However, at present, net government debt is actually also fairly large. Net government debt matters when considering the possibility of government debt default. While some argue that, given the large amount of government debt, even a small increase in interest rates could cause serious problems, it is important to think about the impact in terms of net debt. The reason is that when interest rates rise, interest receipts on financial assets held by the government also increase, partly cancelling out the impact on gross government debt. Chart 2 General Government Fiscal Balance, Gross Government Debt, and Net Government Debt (Ratios Relative to Nominal GDP) % % -2 -4 -6 -8 -10 -12 FY 1994 Fiscal balance Gross government debt outstanding (right scale) Net government debt outstanding (right scale) Source: Cabinet Office, "System of National Accounts." The following articles also note the importance of net debt. Tomoyuki Nakajima and Shuhei Takahashi, "The optimum quantity of debt for Japan," Journal of the Japanese and International Economies, vol. 46, issue C, 17-26, December 2017. Koji Nakamura and Tomoyuki Yagi, "Fiscal Conditions and Long-term Interest Rates," Monetary and Economic Studies, vol. 35, November 2017. III. Why Interest Rates Are Low Since the introduction of QQE, employment has been improving, productivity has been rising, and fiscal conditions have been improving. What, then, is at the core of the problem of bold monetary policy? Simply put, prices have not been rising. Prior to the introduction of QQE, the Bank decided that it would aim to achieve inflation of 2 percent. However, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food for October 2019 is 0.4 percent, a long way off the target.10 You might think that it is not a problem that prices are not rising if employment is improving, productivity is rising, and fiscal conditions are improving. However, if prices do not rise, neither will interest rates, which poses a problem for financial institutions.11 When asked "Why are interest rates in Japan low?" one might answer: "Because that is the Bank's very intention." However, this is not necessarily the case. From a theoretical perspective, maintaining interest rates at low levels will cause the economy to overheat and prices to rise, possibly resulting in inflation that significantly exceeds 2 percent. In order to avoid this, interest rates will need to be raised. Alternatively, they will rise over time in due course. In a nutshell, in the long term, a low interest rate policy brings about increases in prices and nominal interest rates. Looked at from a different angle, what this means is that Japan fell into deflation and a situation of low interest rates because interest rates were not According to the Statistics Bureau, Ministry of Internal Affairs and Communications, the CPI figure becomes 0.2 percent when the effects of the consumption tax hike and the introduction of free preschool education are excluded. 11 I have explained the importance of the 2 percent price stability target in the section titled "Why Is the 2 Percent Inflation Target Important?" in Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Nagasaki," Bank of Japan, May 2019. lowered sufficiently during economic downturns in the past.12 Moreover, this decline in interest rates is actually not unique to Japan, but rather a global phenomenon. Chart 3 shows 10-year government bond yields for major countries. For visual clarity, each point represents a five-year average. Interest rates have been declining globally and, although not visible in the chart, 10-year government bond yields have been negative in Japan, Germany, and France since around the middle of 2019. Chart 3 10-Year Government Bond Yields for Major Countries % -2 CY 1981-85 1986-90 1991-95 1996-00 2001-05 2006-10 2011-15 2016-19 France Germany Japan United Kingdom United States Note: Figures for Japan through 1988 are based on those of the Cabinet Office. Sources: OECD; Cabinet Office. Harada Yutaka, "Naze nihon no kinri wa hikui no ka," Keiki to saikuru, no. 62, Japan Association of Business Cycle Studies, November 2016. Yutaka Harada, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Ishikawa," Bank of Japan, July 2018. Hibiki Ichiue and Yuhei Shimizu, "Determinants of long-term yields: A panel data analysis of major countries," Japan and the World Economy 34-35 (2015) 44-55. While this paper argues that declines in long-term interest rates can be explained by decreases in expected inflation rates and expected labor productivity growth rates, the same can be said of declines in observed inflation rates and labor productivity growth rates as these are also capable of pushing down the expected rates. Ben S. Bernanke, "Why are interest rates so low?" Brookings Institution, March 30, 2015, https://www.brookings.edu/blog/ben-bernanke/2015/03/30/why-are-interest-rates-so-low/. Low interest rates reflect low rates of both real economic growth and inflation. Let us look at the nominal GDP growth rate, which is the sum of these two rates. As can be seen in Chart 4, nominal GDP growth rates of major countries have been declining on the whole. Chart 4 Nominal GDP Growth Rates of Major Countries % France Germany Japan United Kingdom United States -2 CY 1980-85 1985-90 1990-95 1995-00 2000-05 2005-10 2010-15 2015-19 Note: Figures for Germany from 1990 to 1995 are calculated by using the data from 1991 to 1995, since there is a data gap between 1990 and 1991 due to German Unification. Source: IMF, "World Economic Outlook Database." While nominal GDP growth rates have indeed been declining, this alone cannot fully explain the decline in interest rates. In Chart 5, the vertical axis represents 10-year government bond yields, while the horizontal axis represents the nominal GDP growth rates of major countries. Each dot in the chart depicts the five-year average for each country from 1990 to the present. Up until the 2000s, interest rates moved in sync with nominal GDP growth rates and were around 2 percentage points higher than them. However, looking at the trend since the second half of the 2010s, interest rates have fallen 2 percentage points below nominal GDP growth rates and have failed to rise substantially when nominal GDP growth rates increased to some extent. However, because it is only since the start of 2010 that interest rates have been below nominal GDP growth rates, the situation might change quickly and interest rates may rise swiftly if nominal GDP growth rates increase. Therefore, we might not have to expect the situation of the past five to ten years to last forever. Chart 5 Nominal Interest Rates and Nominal GDP Growth Rates 12.0 10-year government bond yields , % 10.0 8.0 1990s Germany, 2010-'14 6.0 France, 2000s 2010-'14 UK, 2010-'14 US, 2010-'14 4.0 Japan, 2010-'14 2010s US, 2015-'19 2.0 UK, 2015-'19 Germany, 2015-'19 0.0 Japan, 2015-'19 France, 2015-'19 -2.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 GDP growth rate, % Note: Dots in the chart show 5-year average of 10-year government bond yields and nominal GDP growth rates. Sources: IMF, "World Economic Outlook Database"; OECD. Why did interest rates fall more than the nominal GDP growth rate? Proposed explanations for the decline in interest rates, in addition to the decline in the rates of inflation and real GDP growth, include changes in the saving-investment balance.13 Various factors are said to be responsible for such changes: demographic forces; higher inequality; the glut of precautionary saving by emerging markets; the decline in the relative price of capital; the high profitability of large IT firms and their large cash reserves; lower public investment; the shortage of safe assets; and the improvement in fiscal conditions. 14 Some argue that the recent decline in interest rates is cyclical and changes in the saving-investment balance might be due to the decline in investment and increase in savings, and that this has led to the decline in interest rates. See Lukasz Rachel and Thomas D. Smith, "Are Low Real Interest Rates Here to Stay?" International Journal of Central Banking, vol. 13 (3), 1-42, September 2017, and other articles through page 117 in this volume of the journal. 14 With regard to the shortage of safe assets, see Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas, "The Safe Assets Shortage Conundrum," Journal of Economic Perspectives, vol. 31 (3), 29-46, Summer 2017. Among the reasons behind the decline in interest rates mentioned earlier, I will focus on the effects of the improvement in fiscal conditions in Japan. First, let us assume that interest rates in Japan are determined by the saving-investment balance in Japan. Another assumption is that a change in fiscal conditions does not affect private-sector decisions with regard to saving and investment. In fiscal 2012, long-term interest rates in Japan were 0.8 percent, while gross national savings, which equal total investment -- the sum of domestic and foreign investment -amounted to 115 trillion yen. The general government deficit declined by 26 trillion yen from fiscal 2012 to fiscal 2017. Due to this decline, gross national savings should have increased by 26 trillion yen. Chart 6 shows the relationship between interest rates and gross national savings, which equal total investment. As the interest elasticity of savings is said to be small, the supply curve of savings is almost vertical. Meanwhile, the investment demand curve is drawn assuming that the interest elasticity of investment is one. The chart indicates that interest rates declined by 0.18 percentage points due to the decline in the general government deficit by 26 trillion yen.15 Chart 6 Fiscal Balance and Interest Rates long-term interest rates, % 2.0 1.5 1.0 0.18%pts. FY 2012 0.5 26 tril. yen 0.0 gross national savings / total investment, tril. yen Sources: Cabinet Office, "System of National Accounts"; Bloomberg. Nakamura and Yagi ibid. (see footnote 9) estimates that, in the case where the ratio of net government debt to GDP exceeds 90 percent, a 1 percentage point increase in the ratio of fiscal deficit to GDP would push up nominal long-term interest rates by 0.26 percentage points. This estimate is around 8 times as much as the one presented in my speech today. While it is difficult to judge whether this decline in interest rates is large or small, what is clear is that, if the government deficit led to a rise in interest rates, this would pose a major problem, as it would reduce important investment and damage Japan's economy in the future; on the other hand, if the government deficit does not lead to a rise in interest rates, it also does not reduce important investment, and would not be a major problem. Arguments That Low Interest Rates Cause Problems In addition to the debate surrounding low interest rates mentioned earlier, it has been argued that the low interest rate policy allows inefficient firms to survive, leading to a decline in productivity and, consequently, a decline in the natural rate of interest. This could be called the "zombie firm argument" -- that is, the argument that low interest rates artificially keep inefficient firms alive.16 Yet another argument is that the current low interest rates are due to low interest rates in the past that brought about a "frontloading" of demand and resulted in a further decline in interest rates.17 First of all, it needs to be noted that these arguments focus on real, not nominal, interest rates. Thus, as for the first argument that the low interest rate policy allows inefficient firms to survive, leading to a decline in productivity, this is implausible given that productivity has been rising as a result of QQE. In addition, if inefficient firms were forced to exit the market because of higher interest rates, this would lead to employment issues. In contrast, Japan's economy is currently facing labor shortages due to monetary easing. If inefficient firms are to be forced to exit the market, it is much better if this occurs through labor shortages and upward wage pressures. With regard to the second argument that the current low interest rates are merely the result of a "frontloading" of future demand, both production and people's incomes have been There had been claims that, due to low interest rates, inefficient firms are able to survive. For example, see "Zonbi kigyō to wa hatan jōtai 'oi kashi' de enmei," Nikkei, February 9, 2019 and Kamei Katsuji, "Zonbi o amayakasu nichigin," Nikkei, October 4, 2019. These referred to the following analysis indicating that the increase in the number of zombie firms is linked to the effects of lower interest rates: Ryan Banerjee and Boris Hofmann, "The rise of zombie firms: causes and consequences," BIS Quarterly Review, Bank for International Settlements, September 2018. 17 See, for example, Okina Kunio, Kinri to Keizai (Tokyo: Diamond, Inc, 2017), 174-177. rising. I assume that when people have higher incomes, they are likely to demand a higher standard of living in the future as well. Owing to the stable exchange rate environment brought about by QQE, more foreign visitors have been coming to Japan. I feel that it is rather strange to think that Japan has merely attracted visitors that were expected to come in the future and that, since these visitors will not come in the future, this would lead to a decline of the economy in the future. When the Bank introduced QQE, I assumed that achieving the inflation target of 2 percent would not take much time. If the inflation rate were to approach 2 percent, the Bank would have to raise interest rates. I therefore did not expect interest rates to stay at around 0 percent or in negative territory for such a long period of time. It seems that many economists had similar expectations.18 Let me go back to the discussion regarding the factors underlying low interest rates. Given that interest rates have fallen 2 percentage points below nominal GDP growth rates, the decrease in the fiscal deficit mentioned earlier cannot fully explain the low interest rates. In fact, the reasons why interest rates have fallen so much are not yet fully understood. However, given that interest rates in the United Kingdom and the United States -- where inflation rates of around 2 percent had been successfully maintained -- have remained higher than interest rates in Japan, it is clear that Japan's past deflationary monetary policy has led to the decline in interest rates. In addition, it is only for the last five or ten years that interest rates have been 2 percentage points below nominal GDP growth rates. Therefore, we might not have to expect this situation to last forever. For example, Hayakawa argues that private banks currently hold huge amounts of government bonds. In terms of quantity, major banks have substantial amounts of government bonds, but the duration of their bonds is little more than two years. Meanwhile, the duration of the bonds held by regional financial institutions is around four years -- longer than that of bonds held by major banks. Since there is little demand for credit from regional financial institutions, such institutions' only option is to buy bonds, which extends the duration of their bonds. If prices of government bonds were to fall, it is regional financial institutions that would incur the greatest losses, not the major banks. For details, see Hayakawa Hideo, "Waga kuni kin'yūgyō no kadai," Shin kokusaku, Research Institute for National Policy, November 2012. This argument is based on the assumption that monetary easing eventually increases interest rates. Also, the idea that government bonds with a duration of four years entail risks reflects the assumption that, in about four years, prices will rise, thereby leading to an increase in interest rates. IV. Low Interest Rates and Banks' Profitability Although it is not clear why, interest rates have fallen globally and are negative, not only in Japan but also in many European countries. Banks are dissatisfied with low interest rates. While these have improved the employment situation and boosted productivity, it frequently is argued that they undermine banks' profitability.19 Functions of Banks Before considering the relationship between low interest rates and banks' profitability, I would like to explain banks' functions. How do banks make profits? Textbooks on finance define the functions of banks as consisting of information production and asset transformation and explain banks' profits as the result of performing these two functions. 20 As for information production, banks, on behalf of depositors, examine borrowers' future profits from investments and the quality of their assets, assess whether the projected outcome has been achieved after a loan was made, and check whether borrowers' accounting information is correct. Banks demand collateral and/or personal guarantees from borrowers. Sufficient collateral and personal guarantees alleviate banks' burdens of monitoring firms' accounting information and therefore reduce the cost of information production. Since depositors cannot demand collateral or personal guarantees, the function of information production falls on banks. If firms provided more detailed accounting information, given that they are sufficiently large, they could obtain funding through capital markets and would not have to rely on bank lending. The reason that in practice most large firms in Japan borrow from banks is that banks provide inexpensive lending to them. This means that lending to large firms is less profitable for banks. While it is very difficult to project future profits to begin with, there are certain firms other than banks that can project the future profits of another firm more accurately. For instance, a large assembler to a certain extent knows the sales figures of its suppliers. The simple reason is that the assembler procures orders from the supplier. Similarly, trading and other See, for example, "Mienu 'deguchi,' fukusayō zōdai: ginkōkai ni takamaru fuman -- mainasu kinri 3-nen," Jiji Press, Ltd., February 15, 2019, https://www.jiji.com/jc/article?k=2019021500887&g=eco. 20 See, for example, Iwata Kikuo, "Kin'yū chūkai to kigyō kin'yū," chapter 4 in Kin'yū (Tokyo: Toyo Keizai Inc., 2000). companies that take part in the management of particular firms may also be better placed to project their future profits. Banks compete with such firms with information advantages. Even if the firms they lend to are very successful, the margin that banks can earn is very small. Since banks are not allowed to invest depositors' money, they cannot invest in venture firms and earn returns that are considerable multiples of their outlays. If banks try to assess the future profits of a firm, which are unknowable, it is the person with the greatest authority that ultimately makes the assessment. If a firm is not managed properly, it likely would face a situation illustrated in the world of novels -- that is, the credit examination division would stop functioning and the human resources division, which is responsible for assessing personnel, would engage in internal power struggles. 21 If banks instead provide loans based only on observable and objective criteria such as collateral, they could cut costs by substantially downsizing their credit examination division and/or human resources division. That is, banks should lend based on observable and objective criteria and examine future profits of firms only in exceptional circumstances. 22 Even by focusing only on the examination of observable and objective criteria, banks would be doing something that depositors cannot. Asset transformation -- banks' other function -- consists of two components. The first is the act of accumulating short-term deposits and transforming them into long-term lending. Since borrowers use funds to buy machinery or construct buildings, they cannot pay back the money on short notice. Banks can lend over the long term by accumulating deposits from a large number of depositors. The second component is the transformation of loan assets, which entail the possibility of default, into risk-free deposits. As a result, depositors can rest assured that their funds are safe when entrusting them to banks. This means that Although fiction, similar situations are vividly described in books focusing on banks written by Jun Ikeido, such as, Oretachi Baburu Nyūkōgumi, (Tokyo: Bungeishunju Ltd., 2004), Shairokku no Kodomotachi, (Tokyo: Bungeishunju Ltd., 2006), and Rosujene no Gyakushū, (Tokyo: Bungeishunju Ltd., 2012). The stories are exaggerated but are more or less similar to fragmentary information that I gained personally. 22 Observable and objective criteria include deposits and withdrawals from firms' accounts as well as deposits on housing rent. There also are cases where lenders, not banks, manage the accounts for deposits on housing rent. banks transform assets that involve risks into safe assets through the function of information production. To what extent can banks maintain the amount of loans by utilizing these functions? There are some landowners that only have a small amount of deposits, but their deposits would increase if they succeed in their business. If the quality of people's lives improves, the number of people who can let their assets lie idle over the long term would increase, leading to a narrowing of the spread between short- and long-term interest rates. As some borrow money even at high interest rates, banks might be able to make loans to them at such rates. However, these people do not represent the majority. Banks can make loans even without sufficient collateral. If a borrower makes a certain down payment to start up a shop, banks can place confidence in the borrower's diligence and steadiness. Even if the amount of collateral is not sufficient for banks, the borrower certainly should be considered serious enough, since all the efforts made over several years would be in vain upon failure. In the case of housing loans, a 10-20 percent down payment might be insufficient for banks. However, it seems that such a down payment level would not cause problems because borrowers would want to keep their houses at all costs. Looking at banks' assets, as of end-September 2019, of the total loans made by domestically licensed banks of 509 trillion yen, 324 trillion yen was for corporations (including 206 trillion yen for small enterprises) and 144 trillion yen for households. 23 As for loans to households, as of end-September 2019, the amount of housing loans was 131 trillion yen and that of consumer loans was 10 trillion yen. 24 I assume that the total amount of loans -those to small enterprises and households combined -- with which banks might be able to gain profits is around 350 trillion yen. Though based on different statistics, as of end-August 2019, of the total loans of 485 trillion yen, the amount of loans made at interest rates of 5 percent or more only stood at 5.9 trillion yen.25 Bank of Japan, Deposits, Vault Cash, and Loans and Bill Discounted. Bank of Japan, Loans to Households. 25 Bank of Japan, Loans and Discounts Outstanding by Interest Rate. Increase in Deposits in Excess of the Increase in Loans at Japanese Banks An increase in deposits in excess of the increase in loans at banks also is a problem. Chart 7 shows the loan-to-deposit ratios (calculated by dividing loans by deposits) of banks in Japan, the United States, the United Kingdom, Germany, and France. In Japan, the ratio, which had been at around 100 percent through the end of the 1990s, declined sharply thereafter and is hovering at around 60 percent at present. On the other hand, the ratios in the other countries, albeit declining, have remained at around 100 percent except in the United States. Banks in those countries accumulate deposits only to the extent necessary to make loans. Even then, banks in Europe have had difficulties maintaining profitability. For banks in Japan that have been accumulating an excessive amount of deposits, the situation should become even more severe. Chart 7 Loan-to-Deposit Ratios of Banks in Major Countries % CY Germany France Japan United Kingdom United States Sources: Bank of Japan; Bank of England; ECB; FRB. From the time of the introduction of QQE up until September 2019, loans by domestically licensed banks, which had been on a declining trend, increased by 79 trillion yen while deposits increased by as much as 161 trillion yen.26 In this context, news reports suggest that financial institutions are struggling to attract personnel and that staff members are Bank of Japan, Financial Institutions Accounts. retiring early.27 While this is reported as though it is troublesome, it consequently could lead to a reduction in the number of personnel contributing to the collection of more deposits than needed and in that of branches. I think that this would increase the productivity of the banking sector, and thus of Japan's economy as a whole. There are concerns that, facing difficulties in expanding lending while accumulating too much deposits, banks in Japan do not seem to be trying to reduce deposits, but instead are relying on riskier lending or investment and recommending that their customers buy investment trusts rather than make deposits. Estimates by the Financial Services Agency (FSA) of customers' total return on investment trusts (after fees and commissions) suggest that, as of end-March 2019, 34 percent of customers of all investment trust distributors face negative total returns.28 Given that the average holding period of such funds is thought to be around three years and that stock prices in major countries have risen during that period, including in Japan, where the Nikkei 225 Stock Average has risen by around 25 percent, the return on most funds should be positive. This means that the negative returns must be due to high fees and commissions. As highlighted by the FSA, some of the distributors of investment trusts seem to be encouraging their customers to churn between funds in the short term to gain profits from transaction fees.29 Moreover, looking at the costs and returns of investment trust funds by type of distributor, I find that banks and securities firms engaged in face-to-face sales tend to sell trusts involving high costs and low returns. In contrast, independent investment trust firms and securities firms specializing in sales via the internet tend to sell trusts at a lower cost and that offer higher returns.30 See, for example, the 2-day series, Minami Takero and Nakatani Shogo, "Chigin haran jinzai kokatsu no kiki," Nikkei, February 20 and 21, 2019. 28 For details, see Financial Services Agency, "Publication of the monitoring results pertaining to the implementation status of customer-oriented business conduct taken by financial institutions" (the full text is available only in Japanese), November 2019, https://www.fsa.go.jp/en/newsletter/weekly2019/367.html. In fact, this situation where customers are making losses in their investment trusts has even made it into works of fiction, such as Shairokku no Kodomotachi (p.16) by Jun Ikeido, mentioned earlier. 29 Toshihide Endo, "To turn challenges into opportunities," Speech at the 34th Annual General Meeting and Reception of the International Bankers Association of Japan, Financial Services Agency, November 2018. 30 See footnote 28 for the reference. Some financial institutions in Europe, where interest rates also are low, are in the process of significantly enhancing their business efficiency due to the prolonged sluggishness of profits. Since drastic employment adjustments in Europe seem to be difficult due to factors such as labor practices, some financial institutions are revising their organizational structure globally, including in Japan. Given that Japan is facing labor shortages due to bold monetary easing, such revisions should be easier than in Europe. If banks successfully can downsize their number or their asset holdings, they would become profitable. In capitalism and a market economy, firms need to switch from unprofitable to profitable business areas. If banks release human resources and capital while making this shift, this will have a positive impact on Japan's economy as a whole. Although I recognize the difficulty of giving up business in Japan, if banks -- which should form the core of capitalism and the market economy -- understand this point, I believe productivity of the economy will improve greatly.31 Concluding Remarks Nearly seven years have passed since the introduction of bold monetary easing in 2013, and almost five years have passed since I was appointed as a Member of the Policy Board of the Bank. Even now, achieving the inflation target of 2 percent seems to be a long way off. Interest rates have not been rising due to low inflation. However, owing to bold monetary easing, economic activity clearly has improved. Employment, especially youth employment, has improved. Had the Bank implemented bold monetary easing since the 1990s, the employment ice age could have been avoided. There also have been various other positive developments, as I mentioned earlier. However, since interest rates have not been rising, banks, which believe their profits would increase with higher interest rates, express growing dissatisfaction. In my opinion, banks' low profitability is caused by the structural problem that they are accumulating more deposits than they can lend and the banking sector as a whole therefore will not be able to maintain its current size. As shown in Chart 5, it is only over the past ten years or so that The solution of shrinking the size of banks is not considered at all in the novels by Jun Ikeido mentioned earlier. I fully understand that it is difficult to implement in practice what is difficult even in the world of fiction. interest rates have failed to rise to any meaningful extent, and thus it might be premature to conclude that it is not possible to see a return to the former situation. If the Bank were to raise interest rates now, this would revive the deflationary mindset and consequently further delay increases in prices and interest rates. This would not benefit the banking sector either. Some argue that the Bank should raise interest rates soon because Japan's economy is in a good state given the demographic trends. However, it was only after the introduction of QQE that real GDP per working-age person started to increase; therefore, raising interest rates would just throw us back. That is, raising interest rates would lead to the following: an appreciation of the yen; falling stock prices; declines in exports, investment, consumption and employment; and the reemergence of the employment ice age. Thank you for your attention.
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Okayama, 12 December 2019.
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December 12, 2019 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Okayama Masayoshi Amamiya 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 Okayama Prefecture. I would like to take this chance to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's Okayama Branch. Yesterday, I looked at the recovery of areas that were severely damaged by the heavy rain in July 2018, such as Mabicho. It was heartbreaking to see that the impact of the disaster remains even after a year and a half has passed. However, at the same time, it was very encouraging to know that the locals are making steady progress toward recovery. I would like to express my deepest respect for everyone's efforts. Before exchanging views with you, I would like to talk about the Bank of Japan's view on developments in economic activity and prices, including the global economy, and about the underlying thinking on its monetary policy conduct. In particular, let me explain these by focusing on three questions that I have received often recently: how long the global economic slowdown will continue; whether it will affect domestic demand; and the degree of the consumption tax hike's impact. I. Financial and Economic Developments I will start by talking about developments in the global economy. Let me first look back at developments over the past few years (Chart 1). From 2017 through mid-2018, the global economy had been firm, supported mainly by global growth in IT-related demand, a resultant boost in business fixed investment, and steady domestic demand in each country. Since around mid-2018, however, the global growth rate and world trade volume have declined, mainly reflecting heightening uncertainties over the U.S.-China trade friction and adjustments in the global cycle for IT-related goods that were affected by weak demand for data centers and smartphones. In particular, the world trade volume started to decrease from the middle of this year. The characteristic of the current slowdown in the global economy is that the manufacturing sector has been relatively weak against the background of the slowdown in trade activity (Chart 2). Business sentiment in the manufacturing sector globally has remained in a state of deterioration. In this situation, machinery investment has remained somewhat weak. In addition, global automobile sales have been somewhat weak due to various factors such as weak corporate demand, which also is observed in machinery investment, the effects of stricter environmental regulations, and the tightening of financial conditions in some emerging economies. There used to be a prevailing view that the global economy would head toward a pick-up in 2019, but the pick-up turned out to be delayed, and many institutions, including the International Monetary Fund (IMF) and the Bank of Japan, had to revise downward their projections for global economic growth. The delay is mainly attributable to the intensified and prolonged U.S.-China trade friction and a continuing decline in the growth rate of the Chinese economy. So, how long will the global economic growth pace continue to be in this deceleration phase? In other words, when will the global economy pick up? The Bank projects that, although it is subject to considerable uncertainties, the growth rate will rise moderately through mid-2020. According to the latest World Economic Outlook (WEO) released by the IMF, the global growth rate for 2019 is projected to decline to 3.0 percent and thereafter recover to 3.4 percent for 2020, which is around the past average (Chart 1). One of the mechanisms through which the global economy will pick up is the materialization of the effects of each country's macroeconomic policy. Since the beginning of this year, many emerging and commodity-exporting economies have reduced their policy rates. As for advanced economies, the Federal Reserve cut its policy rate at three consecutive meetings held from July through October, with a view to preventing an actual slowdown in economic activity and prices due to risks concerning weak global growth, as well as trade developments. The European Central Bank (ECB) also conducted monetary easing in September. These accommodative monetary policy measures will likely support a pick-up in the global economy by stabilizing economic and price developments in each country. At the Federal Open Market Committee (FOMC) held this morning, the Federal Reserve decided not to change its policy. As background to this decision, the Federal Reserve has pointed to the projection that the "insurance" rate cuts in the past few months will likely underpin the U.S. economy. Another driving force of a pick-up in the global economy is a recovery in the global cycle for IT-related goods, which triggered the current global economic slowdown (Chart 3). The global demand for semiconductors is bottoming out, and demand for smartphones and data centers is likely to pick up. In addition, from a somewhat longer-term perspective, demand related to 5G network is expected to increase globally. In this situation, the phase of inventory reductions has almost ended in Japan, and some increase in exports and production of IT-related goods has started to be seen. Moreover, regarding the U.S.-China trade friction, which entails the largest uncertainties over the global economy, negotiations seem to be continuing toward further progress even after the United States postponed imposing additional tariffs on Chinese goods in October. Global financial markets have taken these developments as favorable, and investors' risk sentiment has improved compared to a while ago. If a globally stable trade relationship is rebuilt, that will boost again the global trade, which has shrunk. Although signs of a pick-up in the global economy have started to be observed gradually, uncertainties over the outlook continue to warrant attention and the Bank is cautious about future developments. The U.S.-China trade negotiations have shown positive developments, but points of disagreement between the two countries remain in various aspects, and I have to say that uncertainties over the outcome of the negotiations are still high. In addition, close attention should be paid to various risks, including developments in emerging economies such as China, how the exit from the European Union (EU) will turn out in the United Kingdom, where the general election is going to take place today, and geopolitical risks. As for the outlook, if firms have to keep paying attention to risks concerning the global economy for a prolonged period, it could take longer than expected for their fixed investment stance to become active again. Thus, downside risks concerning the global economy will continue to warrant close attention. Thus far, I have talked about developments in the global economy. Now, I would like to move on to Japan's economic developments. The growth pace in the global economy has remained slow, and this has affected Japan's economy, mainly the manufacturing and export-related industries (Chart 4). Since the turn of the year, manufacturers' sentiment in Japan has become clearly cautious. With regard to exports and production activity, some weakness has continued to be observed, particularly in capital goods used for business fixed investment and automobile-related goods. As for the outlook, these developments are likely to continue for the time being with the pick-up in the global economy being delayed. What is unique to the current phase is that, in contrast to somewhat weak external demand, domestic demand has been firm (Chart 5). In the past, large economic fluctuations often occurred in Japan, where the negative impact on the manufacturing sector stemming from changes in the global economy spread to domestic demand. In the current phase, however, although exports have continued to show some weakness, domestic demand has continued to increase in all three sectors -- that is, the corporate, household, and public sectors. Thus, the impact of the global economic slowdown on domestic demand has been limited so far. The Bank expects that, with the virtuous cycle from income to spending operating, domestic demand will follow an uptrend and the impact of the global economic slowdown on domestic demand will remain limited. That is, although the momentum of domestic demand is likely to decelerate temporarily in the short run, reflecting the effects of the global economic slowdown and the consumption tax hike, it is expected that a large decline will be avoided. In what follows, I will explain the outlook for business fixed investment, private consumption, and public investment in further detail. Let me start with business fixed investment. Business fixed investment in Japan has continued on an increasing trend on the whole, although it has been somewhat weak globally. This is attributable to an increase in sustained investment that is less susceptible to short-term economic developments (Chart 6). Such investment includes labor-saving investment that reflects tight labor market conditions. While the labor market conditions remain tight and labor shortage is expected to continue from the long-term perspective, demand for saving labor and improving efficiency has increased, mainly in the nonmanufacturing sector that is labor intensive. Since Okayama Prefecture, for which the active job openings-to-applicants ratio is ranked in the top three in Japan, faces extremely tight labor market conditions, you may recognize this situation clearly. In industries that face labor shortage -- including retail, accommodations as well as eating and drinking services, and construction -- firms are making efforts to save labor and improve efficiency and actively are undertaking machinery and software investment. In addition, the uptrend in research and development (R&D) investment for growth areas is expected to be maintained. With a view to improving competitiveness from a long-term perspective, the pace of increase in R&D investment is planned to be maintained in industries such as automobiles and chemicals, which recently have been affected by the global economic slowdown. Moreover, construction investment also has maintained a high level, reflecting a wide range of demand, such as for urban redevelopment projects, construction of distribution facilities that results from the spread of e-commerce, and construction of accommodation facilities that aims at capturing inbound tourism demand. Although business fixed investment in Japan as a whole has been on an uptrend, the effects of the global economic slowdown actually have been seen in part (Chart 7). Let us take the example of machinery investment in the manufacturing sector. In particular, machinery investment in industries related to capital goods that are used for fixed investment and to automobiles has been somewhat weak recently. While I mentioned earlier that exports and production in these industries had been greatly affected by the global economic slowdown, the same thing can be said about their business fixed investment. As for the outlook, business fixed investment is expected to maintain its uptrend on average underpinned by sustained investment; in the short run, however, its pace of increase is projected to decelerate, mainly for machinery investment in the manufacturing sector, with the pick-up in the global economy being delayed. Next, I will talk about private consumption. Private consumption has increased moderately, albeit with fluctuations that mainly result from the effects of the consumption tax hike, with the employment and income situation continuing to improve steadily. Regarding developments in private consumption for the time being, the key is the effects of the tax hike in October, and this relates to the third question that I mentioned at the outset (Chart 8). First, looking at developments in consumption prior to the tax hike, in September, which was just before the tax hike, there was a significant increase in demand, or the so-called front-loaded increase in demand, for household electrical appliances such as televisions, daily necessities, and high-end products including luxury goods. However, since the increase in demand had not been significant through August, the overall front-loaded increase in demand was constrained this time compared with that of the previous tax hike, when such increase was observed for quite a long period. Next, let us take a look at developments after the tax hike. Attention needs to be paid to the fact that it is becoming difficult to grasp the underlying trend in consumption due to downward pressure resulting from the effects of natural disasters such as typhoons in October. In fact, consumption-related statistics since October have shown a somewhat large decline, and this seems to be partly affected by the special factor that I just mentioned. Assessing comprehensively by excluding this factor and by taking account of the perception of the relevant industries, a reactionary decline in demand after the tax hike so far does not seem to be as significant as that of the previous tax hike. In addition, downward pressure on private consumption will highly likely be smaller than that of the previous tax hike, underpinned by the government's various support measures for households. That said, attention should continue to be paid to the effects of the tax hike, because they could change depending on, for example, people's sentiment and price developments. Lastly, let me move on to public investment. Last year, the heavy rain affected western Japan, including Okayama Prefecture, and the earthquake in Hokkaido caused disastrous damage. There also was great damage caused by a series of natural disasters this year, such as several typhoons that hit mainly eastern Japan. In the affected areas, progress has been made in construction projects related to restoration and reconstruction. In addition, construction related to national resilience -- which aims at strengthening the ability to maintain the functioning of infrastructure even when natural disasters occur -- is to be implemented intensively across the country through fiscal 2020. In Okayama Prefecture, as part of the urgent flood control project in Mabicho, construction is underway such as for Oda River, which caused severe damage at the time of the heavy rain last year. Moreover, economic policy measures decided by the government a while ago include initiatives to promote restoration and reconstruction from the recent natural disasters as well as to strengthen the framework for disaster prevention. As these developments show, public investment is expected to increase. To summarize what I have talked about so far, regarding the outlook for Japan's economy, exports and production are projected to continue showing some weakness for the time being, with a pick-up in the global economy being delayed. As for domestic demand, the pace of increase is expected to decelerate temporarily due to the effects of the global economic slowdown and the consumption tax hike. However, from a somewhat longer-term perspective, it is expected that domestic demand will remain firm and that, as projected by the IMF, the global economic growth rate will rise. Thus, Japan's economy is likely to continue on an expanding trend, albeit at a moderate pace. II. Price Developments Next, I will explain price developments in Japan (Chart 9). Looking back from a long-term perspective, for many years starting from the late 1990s, Japan's economy was in deflation in terms of a sustained decline in prices. Reflecting this situation, the Bank introduced quantitative and qualitative monetary easing (QQE) in 2013, and since then has pursued powerful monetary easing. At present, Japan's economy is no longer in deflation, in the sense of a sustained decline in prices, with the economy improving significantly and the positive annual CPI inflation taking hold. Turning to recent price developments, the year-on-year rate of change in the CPI excluding fresh food has remained at around 0.5 percent, partly due to the effects of the past decline in crude oil prices and reductions in mobile-related prices. The CPI has continued to show relatively weak developments compared to the economic expansion and tight labor market conditions. This is mainly because the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched among firms and households, due to the experience of prolonged low growth and deflation. Under these circumstances, the consumption tax rate was raised in October. The key point in looking at future price developments is whether firms' price-setting stance will change as a result of the tax hike. I would like to show you two distinctive examples (Chart 10). The first concerns developments in prices of durable goods. As for goods such as televisions and household electrical appliances, an increase and reactionary decline in demand prior to and after the tax hike have been observed. Prices were somewhat strong before the tax hike, when demand increased. However, price-setting has been mixed since the tax hike, when demand declined in reaction to the increase. Whereas the year-on-year rate of change in prices of televisions and laptops -- which have relatively large price fluctuations -- has turned negative since the tax hike, the rate of increase in prices of durable household goods such as refrigerators and vacuum cleaners has remained at a relatively high level. The second example concerns developments in prices of services such as dining-out. In the case of services prices, it can be confirmed that the tax hike has been passed on steadily. While the consumption tax rate for dining-out was raised to 10 percent, the rate for food products, including ready-made meals such as deli food, is unchanged at 8 percent due to the introduction of a reduced tax rate. For this reason, it had been pointed out that the tax hike might not be fully passed on to dining-out prices, reflecting price competition with ready-made meals, and that dining-out prices excluding the consumption tax could weaken. However, looking at developments in such prices in October, it appears that the tax hike has been passed on almost completely. Although the dining-out industry is making efforts to save labor and improve efficiency in response to increases such as in personnel expenses and distribution costs, there have been moves to gradually pass on cost increases that cannot be absorbed through such efforts. This suggests that many dining out-related firms have passed on the tax hike to selling prices. These moves also can be observed in other services. Of course, attention needs to be paid to the fact that firms' price-setting behavior may change depending on future developments in consumption. However, no major change in their price-setting stance has been observed so far and it seems that firms have continued to pass on costs including the consumption tax. Taking account of this situation, I will explain the Bank's view on the outlook for prices. For the time being, it is likely that the year-on-year rate of change in energy prices will remain negative due to the effects of the past decline in crude oil prices, and thereby push down the CPI. However, from a somewhat longer-term perspective, the Bank projects that the inflation rate will rise gradually, with firms' and households' perception of prices improving in a situation where the economy continues on an expanding trend. While it is expected to still take time to achieve the price stability target of 2 percent, the inflation rate is likely to increase gradually toward 2 percent. One of the assumed important mechanisms for the achievement of such price rises is the output gap of the economy as a whole (Chart 11). Looking at the output gap, which shows the balance between aggregate demand and supply, a positive gap has taken hold for the past few years, with demand exceeding supply. Based on the outlook for economic activity that I mentioned earlier, although the output gap is likely to narrow temporarily within positive territory, mainly due to the effects of the global economic slowdown and the consumption tax hike, it is expected to remain at around the current level on average. Under these circumstances, as households' tolerance of price rises increases, reflecting a rise in wages, and firms' stance shifts toward further raising prices, not only firms' moves to pass on cost increases but their active moves to raise prices that reflect developments in demand are likely to be more widespread. With wages and prices continuing to rise, the deeply entrenched mindset and behavior among people based on the assumption that wages and prices will not increase easily are expected to change gradually; accordingly, inflation expectations -- that is, people's expectations for future price developments -- are projected to rise. As these developments show, the Bank recognizes that the momentum toward achieving the price stability target has been maintained, whereby a positive output gap results in an increase in actual prices and then in a rise in inflation expectations, leading to a gradual rise in the inflation rate. III. The Bank's Conduct of Monetary Policy Next, I would like to explain the Bank's conduct of monetary policy. The Bank has been conducting "QQE with Yield Curve Control," aiming to achieve the price stability target of 2 percent (Chart 12). It has pursued powerful monetary easing; specifically, the Bank sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year Japanese government bond (JGB) yields at around zero percent, and has conducted large-scale JGB purchases in the market. The Bank considers that, at present, downside risks to economic activity and prices, mainly regarding developments in the global economy, require the most attention. As I mentioned earlier, there are various downside risks surrounding the global economy. If the materialization of these risks leads to a longer delay in the timing of a pick-up in the global economic growth pace or to a further deceleration in the global economy, Japan's economy inevitably will be affected. In this case, prices could be affected to some extent through downward pressure on the output gap, which is one of the important factors that determine price developments. Based on this recognition, since July, the Bank has clearly shown its policy stance of being tilted toward monetary accommodation. In October, the Bank clarified its stance to maintain the present levels of the policy rates or, depending on the situation, lower them from the present levels, as long as downside risks remain significantly high, as in the current situation. The Bank considers that downside risks to economic activity and prices, mainly regarding developments in the global economy, will continue to warrant close monitoring, and thus the policy stance of being tilted toward monetary accommodation will be appropriate for the time being. It will continue to carefully examine various risks and not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. So far, I have talked about the Bank's basic stance of monetary policy conduct. In such conduct, the Bank considers it important to take into account both the effects and side effects of monetary policy, including those on financial markets and the functioning of financial intermediation. On this point, it recognizes that prolonged downward pressure on financial institutions' profits, with the low interest rate environment and severe competition among financial institutions continuing, could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. Although these risks are judged as not significant at this point, mainly because financial institutions have sufficient capital bases, the Bank will continue to examine these risks as well as those considered most relevant to the conduct of monetary policy and pursue such conduct in an appropriate manner, taking account of developments in economic activity and prices as well as financial conditions. Conclusion Lastly, I would like to say a few words about Okayama Prefecture's economy. Okayama Prefecture's economy has been on a moderate expanding trend on the back of firm domestic demand. While the U.S.-China trade friction as well as relatively weak developments in the Chinese economy are affecting exports and production, business fixed investment has remained at a high level. Private consumption has been on a pick-up trend, although fluctuations in demand resulting from the consumption tax hike have been observed. Despite the severe damage caused by the heavy rain last year, Okayama Prefecture's economy has maintained a virtuous expansionary cycle supported by the hard work of residents, firms, and the local government. Blessed by a favorable climate that earned it the name "The Land of Sunshine," Okayama Prefecture has developed the commerce and logistics rooted in its history as a transportation hub. Its manufacturing industries, as exemplified by the Mizushima Coastal Industrial Zone, have been a driving force in Japanese manufacturing. Moreover, the prefecture is rich in culture, as shown by its many ancient castles, Bizen ware, Korakuen, and the Kurashiki Bikan Historical Quarter, as well as in natural blessings such as its hot springs, fruits, and the delights of Setouchi, which appeal to visitors from Japan and abroad. The promotion of tourism based on these attractions is making progress, and with the "Okayama Art Summit" and the "Setouchi Triennale" having been held this year, many people from Japan and other countries have been visiting Okayama Prefecture. On the other hand, despite these riches, Okayama Prefecture is very similar to other regions in that it has to address the declining and aging population. However, by thinking ahead using their insight, the people of Okayama seem to have overcome various challenges at different times. During the Edo period, under the feudal Ikeda clan, Kojima Bay was reclaimed and agricultural productivity was dramatically improved. In the Meiji period, Magosaburo Ohara introduced the latest technology of the time to lay the foundations for the development of the textile industry and set up a factory providing a work environment that is in line with today's thinking about work-style reforms. Thereafter, with scars from the war remaining, the development scheme for Mizushima was launched in 1952, and the industrial complex that emerged played a leading role in the development of Japan's manufacturing industry. Recently, the promotion of regional development centered on forestry in the north of the prefecture has been bearing fruit and has become a model for regional revitalization nationwide. I hope that the growth potential of Okayama Prefecture will be enhanced through collaborative efforts by its people as well as firms and the local government to build up the prefecture's strengths, as seen in their cooperation aimed at overcoming the damage caused by the heavy rain. The Bank, and in particular its Okayama Branch, will seek to play a part in contributing to the further development of Okayama Prefecture's economy. Thank you for your attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Okayama December 12, 2019 Masayoshi Amamiya Deputy Governor of the Bank of Japan Introduction I. Financial and Economic Developments II. Price Developments III. The Bank's Conduct of Monetary Policy Conclusion Chart 1 I. Financial and Economic Developments Global Economy’s Growth Rate and Trade Volume Global Growth Rate World Trade Volume y/y % chg. 6.0 5.5 y/y % chg. 5.0 4.5 4.0 3.5 3.0 Projections 2.5 Average from 1980 through 2018: +3.5% 2.0 1.5 3.8 3.6 ［Projection］ ［Projection］ 1.0 0.5 3.0 3.4 -1 0.0 -0.5 CY 00 -2 CY 12 Notes: 1. In the left chart, figures for 2019 and 2020 are the IMF's projections as of October 2019. Notes: 2. In the right chart, figures are for real imports. Sources: IMF; CPB Netherlands Bureau for Economic Policy Analysis. Chart 2 I. Financial and Economic Developments Global Economic Slowdown Global Business Sentiment in Manufacturing Sector s.a., DI Motor Vehicle Sales in Major Economies Global Machinery Investment y/y % chg. s.a., ann., mil. units United States Manufacturing PMI China India Euro area CY 15 -1 CY15 CY10 Notes: 1. In the left chart, figures are for the "J.P. Morgan Global Manufacturing PMI." Notes: 2. In the right chart, figures for the United States are based on motor vehicle sales excluding heavy trucks. Figures for the euro area are based on new passenger car registrations. Figures for China and India are based on passenger car sales. Sources: IHS Markit (© and database right IHS Markit Ltd 2019. All rights reserved.); IMF; BEA; ECB; CEIC. Chart 3 I. Financial and Economic Developments Global Cycle for IT-Related Goods Shipments-Inventories Balance of IT-Related Goods in Japan World Semiconductor Shipments s.a., q/q % chg. % points Increase in shipments exceeds that in inventories Shipments - Inventories -10 -20 -5 -30 -40 -10 CY 10 Increase in inventories exceeds that in shipments -50 CY 1 5 1 6 1 7 1 8 1 9 Notes: 1. In the left chart, figures are based on BOJ staff estimates using WSTS data. Notes: 2. In the right chart, figures are for electronic parts and devices. Source: Ministry of Economy, Trade and Industry. Chart 4 I. Financial and Economic Developments Japan’s Exports and Production Exports Industrial Production s.a., CY 2015=100 s.a., CY 2015=100 Capital goods Motor vehicles and related goods IT-related goods Capital goods Motor vehicles CY13 CY13 IT-related goods Note: In the right chart, figures for capital goods exclude those for transport equipment. Figures for IT-related goods are for electronic parts and devices. Sources: Ministry of Economy, Trade and Industry; Ministry of Finance; Bank of Japan. Chart 5 I. Financial and Economic Developments Domestic Demand Domestic Demand and Exports s.a., CY 2012=100 s.a., CY 2012=100 Breakdown of Domestic Demand s.a., CY 2012=100 s.a., CY 2012=100 Domestic demand (left scale) Private consumption (left scale) Public demand (left scale) Exports (right scale) Private non-resi. investment (right scale) CY 12 CY 12 Notes: 1. In the left chart, figures for domestic demand are the sum of private consumption, private residential investment, private non-residential investment, and public demand (government consumption and public investment). Notes: 2. In the right chart, figures for public demand are the sum of government consumption and public investment. Source: Cabinet Office. Chart 6 I. Financial and Economic Developments Business Fixed Investment Research and Development Investment Software Investment 400 FY 2005=100 Construction Firms' plans Retailing Accommodations, eating & drinking services All industries FY 2012=100 s.a., ann., tril. yen Firms' plans All industries Transport equipment Chemicals Construction Investment FY 05 FY 12 13 14 15 16 17 18 19 CY 05 07 09 11 13 15 17 19 Notes: 1. In the left chart, figures through fiscal 2018 are actual results. Figures for fiscal 2019 are forecasts from the September 2019 survey. Notes: 2. In the middle chart, figures are for firms with capital of 1 billion yen or more on a consolidated basis. Figures for fiscal 2019 are based on BOJ staff calculations adjusted for average changes from planned to actual expenditure for fiscal 2012-2018. Notes: 3. In the right chart, figures are the estimated construction costs of private nonresidential buildings. Sources: Development Bank of Japan; Ministry of Land, Infrastructure, Transport and Tourism; Bank of Japan. Chart 7 I. Financial and Economic Developments Machinery Orders Capital Goods-Related Industries and Automobile-Related Industries Manufacturing and Nonmanufacturing s.a., CY 2012=100 s.a., CY 2012=100 General-purpose, production, and business-oriented machinery Automobiles, parts, and accessories Manufacturing Nonmanufacturing CY12 CY12 Note: In the left chart, figures for nonmanufacturing exclude those for ships and electric power companies. Source: Cabinet Office. Chart 8 I. Financial and Economic Developments Developments in Consumption Prior to and After the Tax Hikes Overall Household Electrical Appliances s.a., average 16-18 months before the tax hike=100 October 2019 tax hike April 2014 tax hike -18 months-12 -6 +6 +12 +18 150 s.a., average 16-18 months before the tax hike=100 -18months-12 -6 +6 +12 +18 Department Stores Nondurable Goods 108 s.a., average 16-18 months before the tax hike=100 130 s.a., average 16-18 months before the tax hike=100 -18months-12 -6 +6 +12 +18 -18 months-12 -6 +6 +12 +18 Notes: 1. Month 0 is the month in which the consumption tax rate was raised -- namely, April 2014 or October 2019. Notes: 2. In the upper charts and lower left chart, figures are for the Consumption Activity Index (real, travel balance adjusted only for the upper left chart). In the lower right chart, figures are from the "Current Survey of Commerce" (nominal). Sources: Ministry of Economy, Trade and Industry; Bank of Japan, etc. Chart 9 II. Price Developments Consumer Prices Long-Term Developments Recent Developments y/y % chg. y/y % chg. Effects of consumption tax hikes and free education policies Energy CPI (less fresh food) -1 -2 -1 Others CPI (less fresh food) -2 -3 CY 95 CY 1 4 Note: In the left chart, figures are adjusted for the effects of the consumption tax hike in April 2014. Source: Ministry of Internal Affairs and Communications. Chart 10 II. Price Developments Developments in Prices Prior to and After the Tax Hike y/y % chg. 2019/Q1 Q2 Q3 October -2 -4 -6 Durable goods assisting housework (refrigerators, vacuum cleaners, etc.) TV sets Durable goods Source: Ministry of Internal Affairs and Communications. Laptops Dining-out Domestic Services Recreational Personal care services related to services services (charges for clothing (hotel charges, housekeeping (laundry lesson fees, services, etc.) charges, etc.) etc.) Services Chart 11 II. Price Developments Output Gap 4 % Excess demand -2 -4 -6 Excess supply -8 CY 07 Note: Figures are based on BOJ staff estimates. Source: Bank of Japan. Chart 12 III. The Bank's Conduct of Monetary Policy BOJ's Conduct of Monetary Policy Yield Curve Control Taking account of developments in economic activity and prices as well as financial conditions, the Bank facilitates the formation of the yield curve that is considered most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent. 1.0 0.8 % Recent 0.6 0.4 0.2 Short-term policy interest rate: minus 0.1 percent Target level of the long-term interest rate: around zero percent 0.0 -0.2 -0.4 -0.6 0 1 2 3 4 5 6 7 8 9 10 15 20 residual maturity, year Source: Bloomberg. Stance of Monetary Policy Conduct and Forward Guidance (Stance of Monetary Policy Conduct) In a situation where downside risks to economic activity and prices, mainly regarding developments in overseas economies, are significant, the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. (Forward Guidance for the Policy Rates) As for the policy rates, the Bank expects shortand long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. 12■
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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 2019.
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December 26, 2019 Bank of Japan Toward Sustaining a Virtuous Cycle 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. It is only a week before the first year of the new Reiwa era comes to an end. Today, in wrapping up 2019, I would first like to take a look back at this year's economic developments at home and abroad and talk about the Bank of Japan's conduct of monetary policy. Then, I will touch on developments in Japan's economy from a somewhat long-term perspective and future challenges. Specifically, I will explain the mechanism of the virtuous cycle operating in Japan's economy and the challenges to sustaining this cycle. I. This Year's Economic Developments at Home and Abroad Continued slowdowns in the global economy Starting with a look back at developments in the global economy this year, slowdowns have continued to be observed (Chart 1). At this meeting three years ago, I said that the global economy finally seemed to be entering a new phase by putting the negative legacy of the global financial crisis behind it. In fact, the global economy registered relatively high growth in 2017 and 2018, partly reflecting a global increase in IT-related demand and a boost in business fixed investment. However, a phase shift started from around mid-2018. This is mainly because tension over the U.S.-China trade friction began to heighten and the global cycle for IT-related goods entered into an adjustment phase. Back then, there seems to have been a prevailing view that adjustments would come to an end shortly and the global economy would head toward a pick-up in the second half of 2019. However, it turned out that it remained in a deceleration phase for the whole year. A pick-up in the global economy has been delayed, due mainly to the intensified and prolonged U.S.-China trade friction and the continued slowdown in the Chinese economy, and the global economy has not yet moved out of this situation. What is the outlook for the global economy next year? The Bank projects that the growth rate will rise moderately through mid-2020, although it is subject to considerable uncertainties. According to the latest World Economic Outlook (WEO) released by the International Monetary Fund (IMF), the global growth rate also is projected to recover to 3.4 percent for 2020, which is around the past average, from 3.0 percent for 2019. There are three major reasons behind the Bank's projection. First is that uncertainties over the global economy, including developments in U.S.-China trade negotiations, have eased somewhat. As I explained earlier, the global economic slowdown this year is attributable mainly to political and geopolitical uncertainties, such as the U.S.-China trade friction and Brexit. It is significant that these uncertainties have been easing, at least to some extent. Second is that the global cycle for IT-related goods, which had been exerting downward pressure on the global economy this year, has been picking up. World semiconductor shipments recently have turned to an increase. The adjustment phase of the global cycle for IT-related goods, which started from around mid-2018, finally seems to be coming to an end. Third is the effects of each country's macroeconomic policy. Since the turn of this year, many emerging economies have reduced their policy rates, and the Federal Reserve and the European Central Bank (ECB) have conducted monetary easing. This is likely to underpin the global economy. However, the Bank considers that downside risks regarding such outlook for the global economy remain significant. As for U.S.-China trade negotiations, there remain points of disagreement between the two countries, such as those regarding industrial policy. In addition, it is necessary to pay attention to such factors as uncertainties over emerging economies and geopolitical risks. Thus, future developments in the global economy likely will continue to warrant close attention for the time being. Developments in Japan's economy Next, I will talk about Japan's economy (Chart 2). Looking back on this year, reflecting the effects of the global economic slowdown, exports have continued to show some weakness and manufacturers' sentiment has become cautious. On the other hand, domestic demand has continued on an uptrend, and nonmanufacturers' sentiment has remained at a high level on the whole. In the past, there were many cases in Japan where changes in the global economy or external demand affected overall developments in the economy relatively quickly. However, what is unique to the current phase is that domestic demand has remained firm so far despite weak external demand. One factor underpinning firm domestic demand is business fixed investment. According to the December Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment is planned to continue increasing steadily (Chart 3). This increase in business fixed investment is underpinned by sustained investment that is less susceptible to short-term economic developments, including labor-saving and efficiency-improving investment, construction investment, and research and development (R&D) investment for growth areas. This likely has brought about firm domestic demand that is unlikely affected by external demand. In addition, private consumption has continued to increase moderately on the back of steady improvement in the employment and income situation. For the time being, the effects of the October 2019 consumption tax hike warrant attention. Private consumption registered a somewhat large decline for October, partly affected by natural disasters such as typhoons. However, excluding those effects, a reactionary decline in demand after the tax hike seems to be smaller than that of the previous tax hike in 2014. As for the outlook, domestic demand is likely to follow an uptrend with a virtuous cycle from income to spending operating. Although its pace of increase is expected to decelerate temporarily, affected by the global economic slowdown to date, the consumption tax hike, and natural disasters, a large decline likely will be avoided. In addition, the global growth rate is projected to rise. Under these circumstances, Japan's economy is expected to continue on a moderate expanding trend. Let me move on to price developments (Chart 4). Looking back on this year, the year-on-year rate of increase in the consumer price index (CPI) excluding fresh food has decelerated somewhat, partly due to the effects of the decline in energy prices. However, that excluding fresh food and energy, which more clearly shows the underlying trend in the CPI, has been somewhat higher compared to last year. As for the outlook, the year-on-year rate of change in the CPI is likely to increase gradually toward the price stability target as firms' and households' perception of prices improves amid the continuation of the expanding economic trend. II. The Bank's Conduct of Monetary Policy Next, I will talk about the Bank's conduct of monetary policy. The Bank has pursued powerful monetary easing with the aim of achieving the price stability target of 2 percent since the introduction of quantitative and qualitative monetary easing (QQE) in 2013 (Chart 5). In this situation, as the global economic slowdown continued and downside risks to Japan's economic activity and prices became significant this year, the Bank clarified its policy stance of being tilted toward monetary accommodation since around summer. In October, with a view to making this clearer, the Bank decided on a new forward guidance, whereby it would maintain the policy rates at their present levels or, depending on the situation, lower their levels, as long as downside risks to economic activity and prices remain significantly high. While continuing to carefully examine various risks, the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. Meanwhile, early this month, the government released the Comprehensive Economic Measures to Create a Future with Security and Growth. Recently, the cooperation between monetary and fiscal authorities increasingly has been drawing attention globally, so let me explain the basic thinking on it. If the government implements fiscal policy when a central bank pursues monetary easing to achieve its inflation target, economic stimulus effects will become more powerful through their synergy effects. Such a combination of policies is called a policy mix, and this is a standard approach of macroeconomic policy. Therefore, the economic measures that the government recently has implemented can exert significant effects to maintain the expanding trend in the economy with the Bank's pursuit of powerful monetary easing. That said, the cooperation between monetary and fiscal authorities entails difficulties in terms of ensuring public confidence toward macroeconomic policy. In economic theory, a policy mix is assumed to be conducted in an appropriate manner through monetary and fiscal policies based on their own particular policy objectives. In recent discussions, however, some seem to confuse a policy mix with debt monetization by central banks. Thus, it is important to clarify each role when considering the monetary-fiscal policy mix. In the joint statement released by the government and the Bank of Japan in January 2013, they took this point into account and made it clear. The government and the Bank confirmed in the statement that they would work within their respective autonomies to fulfill their own roles, and this framework seems to be functioning very effectively. III. Toward Sustaining a Virtuous Cycle I have looked back at this year's developments in economic activity at home and abroad and explained the Bank's monetary policy conduct during the period. In what follows, I would like to talk about developments in Japan's economy from a somewhat long-term perspective. Japan's economy has improved significantly since the introduction of QQE in 2013. Three virtuous mechanisms have been operating behind this. The first is the virtuous cycle from income to spending in the corporate sector. The second is the same virtuous cycle in the household sector. And the third is the virtuous cycle that has been operating between the corporate and household sectors, whereby an increase in corporate profits leads to a rise in wages, which enables firms to raise their selling prices, resulting in a further increase in corporate profits. It is important not to disrupt these virtuous cycles in order to achieve sustainable economic growth in Japan. Today, I would like to focus on two cycles that in particular are most relevant to business managers: (1) a cycle from income to spending in the corporate sector and (2) a cycle of wages and prices. Cycle from Income to Spending in the Corporate Sector Let me first talk about the cycle from income to spending in the corporate sector. Looking back from a somewhat long-term perspective, the collapse of the bubble economy in the 1990s was a significant turning point in Japanese firms' behavior (Chart 6). After the bubble burst, firms were negative toward undertaking fixed investment for a prolonged period, mainly against the background of the burden brought about by excess production capacity that was accumulated during the bubble period and of corporate profits remaining low under the following deflation. Moreover, this hampered the accumulation of capital stock and innovation, and became one of the factors that lowered Japan's growth potential. A remarkable change in this situation was observed after the introduction of QQE in 2013 (Chart 7). To begin with, corporate profits have improved clearly. Although they recently have shown some weakness in part, due to the effects of the slowdown in overseas economies, they have remained at historical high levels. In this situation, business fixed investment has turned to an uptrend gradually. However, even after 2013, compared to favorable corporate profits, some cautiousness has remained in firms' fixed investment stance, and firms have continued to save most of their profits (Chart 8). One of the multiple factors behind this seems to be a rise in demand for precautionary saving on the firms' side, in reflection of the experience of severe recessions, such as the collapse of the bubble economy and the global financial crisis. However, firms' fixed investment stance clearly has become active for the past few years, with corporate profits remaining at high levels. Although earned surplus has continued to increase, cash and deposits have stopped accumulating since 2018. The proportion of business fixed investment relative to cash flow has increased, and firms have come to use much of their profits for fixed investment. In addition, the current steady business fixed investment -mainly in terms of sustained investment -- despite weak external demand seems to be attributable partly to firms' fixed investment stance, which is generally becoming active. Firms' active stance toward fixed investment also can lead to a rise in Japan's growth potential through an accumulation of capital stock and a rise in productivity. Of course, economic policies such as structural reforms can contribute to enhancing this potential. Monetary policy also has played a part in a rise in growth potential; due to powerful monetary easing, Japan's economy is no longer in deflation and firms' overly pessimistic view has eased. However, the main driving force of a rise in growth potential is the private sector, and the mutual interaction between firms' innovation and investment is more important than anything else. In order to further enhance Japan's growth potential, firms need to continue with positive investment that leads to the creation of new values and an improvement in productivity. IT investment to address the digitalizing society is expected to be one of the areas of such positive investment. Japanese firms already have made efforts in this area (Chart 9). R&D expenditure during the past few years has been pushed up largely by investment in automobile-related industries. The increase reflects moves toward advancing CASE technologies -- connected, autonomous, shared & service, and electric -- of automobiles in response to the digitalization. The progress in such firms' efforts is desirable particularly in terms of enhancing Japan's growth potential. Let me give you two reasons why this is the case. First, since the labor supply is likely to decrease along with the declining and aging population in Japan, the substitution of IT investment for employment has rather positive effects. Regarding the impact of IT investment on the economy, some raise concern that employment opportunities will be lost and the number of unemployed may increase. However, in Japan, the negative impact of a decline in labor force on economic growth can be offset by IT investment compensating for the future decline in labor supply. Second, overall productivity will be enhanced through the advances in digitalization. On this point, some argue that, among the general-purpose technologies, the productivity improvement effects brought about by IT such as computers and the internet are smaller than those brought about by electricity and internal-combustion engines. Such pessimistic views on IT have been presented by, for example, Professor Robert Gordon of Northwestern University, but there are various counterarguments against this. Erik Brynjolfsson, Professor at the Massachusetts Institute of Technology, noting that innovation will occur by connecting a variety of existing products and ideas, states that IT is the general-purpose technology that can lead to innovation more easily compared to electricity and internal-combustion engines, because it enabled the connection of brand-new products and ideas through networks. Given that the development of such cutting-edge applied technology as artificial intelligence (AI) and Internet of Things (IoT) is underway, I suppose innovation brought about by the advances in digitization will improve productivity, and this can be evaluated as favorable. On this basis, how firms make use of technologies also is important in order to strengthen growth potential through IT investment. According to a survey asking Japanese and U.S. firms why they have increased their IT-related budgets, many Japanese firms answered in the 2013 survey that it was to improve business efficiency and cut costs (Chart 10). On the other hand, U.S. firms seemed to have focused on so-called aggressive investment, in that they aimed at incorporating new technologies to encourage innovative initiatives such as developing products and services. Although there already had been such a contrast between Japanese and U.S. firms, a significant change was observed in the 2017 survey. That is, Japanese firms also have started to make more active use of technologies to enhance value-added through innovation, rather than only utilizing them to cut costs and streamline production processes. Since Japanese firms are good at making process innovation, I hope that they will proceed further with the current innovations, thereby raising productivity. In order to foster various innovations by firms, it is essential to promote basic research to support them (Chart 11). For example, "the number of highly cited papers," which is a proxy indicator of basic research, unfortunately is much smaller in Japan than in other countries. Providing sufficient funds may be important to raise the level of such research. On this point, in addition to financial support from the government, it is hoped that the flow of funds from industries to universities will be boosted. Although some statistics show that the proportion of firms providing universities with R&D funds is relatively smaller in Japan than in other countries, Japanese firms have been collaborating with universities by proposing research topics to them. Statistics by the Organisation for Economic Co-operation and Development (OECD) show that R&D funds in Japan are not at all small compared to other countries. I expect that a further promotion of collaboration among industry, academia, and the government will raise the potential of basic research in Japan into the future, and in turn boost the growth potential of the overall economy. Cycle of wages and prices I now will move on to the second virtuous cycle. As I said earlier, an increase in corporate profits leads to a rise in wages, enabling firms' selling prices -- that is, general prices -- to rise, which results in a further increase in corporate profits. In order for corporate profits to increase in a sustainable manner, it is important that a virtuous cycle of wages and prices continue to operate. After the introduction of QQE in 2013, the practice of base pay increases, which had been lost under deflation, has continued for six consecutive years (Chart 12). In this situation, the positive inflation rate has taken hold and Japan's economy already is no longer in deflation. That said, the virtuous cycle of wage increases and price rises still lacks strength. One of the reasons behind this is that, due to the long experience of a severe employment situation under deflation, both labor and management have come to prioritize the stability of long-term employment over wage increases, and this behavior has been deeply entrenched even after wages started rising. The lack of strength in the virtuous cycle also is attributable to the fact that firms have absorbed the upward pressure of costs such as personnel expenses by raising productivity, and only moderately passed on such cost increases to selling prices. Some of you might think that raising wages and selling prices amid a situation of severe competition is not a viable option. However, realizing an economy where wages and prices rise moderately is beneficial from the viewpoint of corporate management as well. Let me raise two points. First, given that it is difficult in general to lower the level of nominal wages, if there is some room to reduce the wage growth rate, it will be easier for firms to adjust labor costs in the event of an economic downturn. I mentioned earlier that, in Japan, the stability of employment was prioritized over wage increases under prolonged deflation. However, an empirical analysis suggests that, excluding such an extreme case, it is difficult for firms to lower the level of nominal wages, or in economic terms, there is downward rigidity in nominal wages. Provided that wage growth and inflation are zero in a situation where economic activity neither accelerates nor decelerates, there is no other choice but to cut employment or lower wages in order to adjust labor costs in an economic downturn. However, if wage growth and inflation are sufficiently positive, firms can adjust real labor costs by lowering the wage growth rate. In relation to this, economist James Tobin argued that positive inflation acts as the "grease of the wheels" in the labor market. Second, aiming at achieving the price stability target of 2 percent as in other advanced economies will lead to stability in foreign exchange rates from a long-term perspective. This is based on the idea of purchasing power parity, whereby the long-term trend of nominal exchange rates is determined by the difference in inflation compared to other countries. In fact, price differences between Japan and other countries have shrunk with the positive inflation rate taking hold in Japan, and nominal exchange rates have been stable from a long-term perspective. Such stability in foreign exchange rates has contributed to corporate management and the stability of the overall economy. Thus, moderate rises in wages and prices are beneficial for firms as well. In addition, as I mentioned earlier, in order for corporate profits to increase in a sustainable manner, it is necessary to maintain a virtuous cycle in the overall economy in which prices rise moderately along with wage increases. In fact, the past data suggest that wages and prices generally move in tandem on average, and a rise in only one of them usually does not occur. Although I said that the virtuous cycle of wage increases and inflation still lacks strength, positive changes have been observed recently (Chart 13). Households' tolerance of price rises has increased, albeit moderately, on the back of improvement in the employment and income situation, as seen in continued base pay rises. Under these circumstances, firms' stance has shifted toward further raising prices. As for the price-setting stance of firms that are closely related to consumption, the output prices DI for consumption-related industries shows that the proportion of enterprises, including small ones, answering that output prices have risen has continued to exceed the proportion of those answering that such prices have fallen, and the gap has been expanding, albeit at a moderate pace. In an economy where the price stability target of 2 percent has been achieved, if labor productivity rises by around 1 percent, as in Japan's economy at present, the wage growth rate would be around 3 percent; that is, 2 percent inflation plus 1 percent labor productivity. On this point, minimum wages have been raised by around 3 percent for four consecutive years from 2016. I hope that firms' stance will continue to shift toward further raising wages and prices under the favorable economic environment, and that a virtuous cycle of wages and prices will gain further strength. Conclusion As we are almost out of time, I would like to conclude my speech. Today, I talked in some detail about the challenges to sustaining the virtuous cycle of Japan's economy from the viewpoint of expectations for firms. I also touched on the importance of (1) firms continuing with positive investment, which leads to enhancing productivity, in order to raise the economic growth potential and of (2) making firms' stance shift toward further raising wages and prices to strengthen the virtuous cycle of wages and prices. Next year, the Olympic and Paralympic Games will be held in Tokyo. The previous Tokyo Games were hosted in 1964, and back then, Japan was full of energy during the period of high economic growth. Looking back on that year, there was a series of historical events that boosted people's confidence, such as joining the OECD in April as well as launching the Tokaido bullet train and hosting the Olympic Games in October. On the other hand, economic expansion that had lasted for two years, dubbed the Olympics boom, had its peak in October 1964 and Japan's economy experienced a downturn for a year thereafter. From this experience, some worry about economic activity from the second half of next year, but there is no need to be too pessimistic. Japan's economy has improved significantly, with the virtuous cycle operating. Corporate activities, which had remained cautious, steadily have become vigorous. The Bank will continue to firmly fulfill its responsibility as a central bank of achieving the price stability target so that Japan's economy will grow in a sustainable manner under the virtuous cycle of the economy. I would like to close my speech by expressing my sincere hope that the year 2020 will be a wonderful one for all of you. Thank you for your attention. Toward Sustaining a Virtuous Cycle Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo December 26, 2019 Haruhiko Kuroda Governor of the Bank of Japan Introduction I. This Year's Economic Developments at Home and Abroad II. The Bank's Conduct of Monetary Policy III. Toward Sustaining a Virtuous Cycle Conclusion Chart 1 I. Economic Developments Global Economy Global Growth Rate 6.0 World Semiconductor Shipments y/y % chg. s.a., q/q % chg. 5.5 5.0 2020: +3.4% 4.5 4.0 3.5 3.0 2.5 2019: +3.0% Average from 1980 through 2018: +3.5% 2.0 1.5 -5 1.0 0.5 0.0 -0.5 CY 00 -10 CY 10 Notes: 1. In the left chart, figures for 2019 and 2020 are the IMF's projections as of October 2019. Notes: 2. In the right chart, figures are based on BOJ staff estimates using WSTS data. Source: IMF. Chart 2 I. Economic Developments Japan's Economy Business Conditions DI Domestic Demand and Exports s.a., CY 2012=100 s.a., CY 2012=100 DI ("favorable" - "unfavorable"), % points "Favorable" "Unfavorable" Nonmanufacturing -10 Manufacturing Domestic demand (left scale) -20 Exports (right scale) CY 12 -30 CY 10 Note: In the left chart, figures for domestic demand are the sum of private consumption, private residential investment, private non-residential investment, and public demand (government consumption and public investment). Sources: Cabinet Office; Bank of Japan. Chart 3 I. Economic Developments Business Fixed Investment and Private Consumption Developments in Consumption prior to and after the Tax Hikes Business Fixed Investment Plans 10 y/y % chg. s.a., average 16-18 months before the tax hike=100 FY 2019 April 2014 tax hike FY 2018 October 2019 tax hike average (FY 2004-2018) -2 Mar. June Sept. Dec. Forecast -18 Actual months -12 -6 +6 +12 Notes: 1. In the left chart, figures are for all industries including financial institutions. Figures include software and R&D investment and exclude land purchasing expenses. Notes: 2. In the right chart, month 0 is the month in which the consumption tax rate was raised -- namely, April 2014 or October 2019. Figures are for the Consumption Activity Index (real, travel balance adjusted). Sources: Bank of Japan, etc. +18 Chart 4 I. Economic Developments Consumer Prices 2.0 y/y % chg. CPI (less fresh food) CPI (less fresh food and energy) 1.5 1.0 0.5 0.0 -0.5 -1.0 CY 12 Note: Figures are adjusted for the effects of the consumption tax hike in April 2014. Figures incorporate the effects of the October 2019 tax hike and policies concerning the provision of free education. Source: Ministry of Internal Affairs and Communications. Chart 5 II. The Bank's Conduct of Monetary Policy BOJ's Conduct of Monetary Policy Stance of Monetary Policy Conduct and Forward Guidance Yield Curve Control Taking account of developments in economic activity and prices as well as financial conditions, the Bank facilitates the formation of the yield curve that is considered most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent. 1.0 % Recent 0.8 0.6 0.4 0.2 Short-term policy interest rate: minus 0.1 percent Target level of the longterm interest rate: around zero percent (Stance of Monetary Policy Conduct) In a situation where downside risks to economic activity and prices, mainly regarding developments in overseas economies, are significant, the Bank will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. (Forward Guidance for the Policy Rates) 0.0 -0.2 -0.4 -0.6 0 1 2 3 4 5 6 7 8 9 10 15 20 residual maturity, year As for the policy rates, the Bank expects shortand long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost. Source: Bloomberg. Chart 6 III. Toward Sustaining a Virtuous Cycle Potential Growth Rate y/y % chg. Total factor productivity Capital input Labor input Potential growth rate -1 -2 FY 85 Note: Figures are based on BOJ staff estimates. Source: Bank of Japan. Chart 7 III. Toward Sustaining a Virtuous Cycle Corporate Profits and Business Fixed Investment Ratio of Current and Operating Profits to Sales Investment-GDP Ratio (Nominal) s.a., % Introduction of QQE s.a., % Introduction of QQE Ratio of current profits to sales Ratio of operating profits to sales CY 85 CY 94 96 98 00 02 04 06 08 10 12 14 16 18 Note: In the left chart, figures exclude "finance and insurance." Figures from 2009/Q2 onward exclude "pure holding companies." Sources: Ministry of Finance; Cabinet Office. Chart 8 III. Toward Sustaining a Virtuous Cycle Active Business Fixed Investment Stance Earned Surplus, and Cash and Deposits CY 2010 average=100 Investment Ratio % Earned surplus Cash and deposits Investment / (operating cash flows + personnel expenses) CY 07 08 09 10 11 12 13 14 15 16 17 18 19 FY 85 Notes: 1. Figures exclude "finance and insurance." Notes: 2. In the right chart, operating cash flows = net income - dividends + depreciation expenses + Δprovisions - Δinventories - Δtrade credits - Δnet amount of other current assets. Investment includes land purchasing expenses and excludes software and R&D investment. Source: Ministry of Finance. Chart 9 III. Toward Sustaining a Virtuous Cycle Developments in R&D Investment 3.0 chg. from FY 2009, tril. yen Nonmanufacturing Other manufacturing Electrical machinery General-purpose, production, business-oriented machinery Medicines Transportation equipment Total 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 FY 10 Source: Ministry of Internal Affairs and Communications. Chart 10 III. Toward Sustaining a Virtuous Cycle Reasons for IT Investment Aggressive Defensive Prompt responses to changes in markets/customers Regular system Use of new technologies/ updates products/services Introduction of IT to non-IT business processes Greater business efficiency/ cost cut using IT Japan 2017 Innovation in business models using IT Enhanced development of products/services using IT Japan 2013 Expansion in firm size Responses to laws and regulations United States 2013 Enhanced analysis of customer behavior/markets using IT Expansion in business operations/ product lines Increasing sales Increasing profits Note: Figures are based on the 2017 JEITA/IDC Japan survey. Source: JEITA. Chart 11 III. Toward Sustaining a Virtuous Cycle Basic Research Highly Cited Papers and R&D Funds from Firms to Universities International Comparison of R&D Investment The number of highly cited papers The proportion of firms' R&D funds provided to universities (%) United States 38,347 1.1 China 28,386 2.7 United Kingdom 8,718 2.0 Germany 7,591 3.8 France 4,716 1.1 Japan 3,927 0.7 ratio to GDP, %, CY 2016 Business sector Government sector Others Japan Germany United France States China United Kingdom Notes: 1. In the left chart, figures for the left column are from "Japanese Science and Technology Indicators 2019," NISTEP RESEARCH MATERIAL No. 283, National Institute of Science and Technology Policy, Tokyo. Figures for the right column are calculated by BOJ staff based on this material. 2. As for the left column in the left chart, the number of highly cited papers is the adjusted number of papers ranked in the top 10 percent in terms of citation counts in each field and each year. Based on the fractional counting method. 2015-2017 average. 3. As for the right column in the left chart, figures for the United States, China, and Japan are for 2017; those for the United Kingdom and Germany are for 2016; that for France is for 2015. Sources: OECD; National Institute of Science and Technology Policy. Chart 12 III. Toward Sustaining a Virtuous Cycle Nominal Wages and Consumer Prices Scheduled Cash Earnings and Base Pay Increase y/y % chg. Consumer Prices Base pay increase Scheduled cash earnings (full-time employees) Introduction of QQE y/y % chg. CPI (less fresh food and energy) Average from FY 2013: +0.5% -1 -2 -1 FY 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 -3 CY88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Average from FY 1998 through FY 2012: -0.4% Note: In the right chart, figures are adjusted for the effects of the consumption tax hikes. Figures incorporate the effects of the October 2019 tax hike and policies concerning the provision of free education. Sources: Ministry of Health, Labour and Welfare; Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Ministry of Internal Affairs and Communications. Chart 13 III. Toward Sustaining a Virtuous Cycle Households' Tolerance of Price Rises and Firms' Price-Setting Stance Output Prices DI for Consumption-Related Industries Households' Tolerance of Price Rises DI ("favorable" - "unfavorable"), % points DI ("rise" - "fall"), % points Firms' forecasts -10 -5 Large enterprises -20 Small enterprises -10 -30 -15 CY 83 -40 CY07 Notes: 1. In the left chart, figures for 2004/Q4 onward are taken from the Opinion Survey on the General Public's Views and Behavior. Figures prior to 2004/Q4 are extrapolated backward using the overall livelihood DI in the "Consumer Confidence Survey." The average of figures for 2004/Q4 onward is normalized to zero. 2. In the right chart, figures are calculated as the weighted average of the DI for changes in output prices in "retailing," "services for individuals," and "accommodations, eating & drinking services." The number of reporting enterprises is used as weights. Sources: Bank of Japan; Cabinet Office.
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Opening remarks by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at the Symposium "The Impact of Natural Disasters on Financial Markets and Financial Institutions", Nagoya City University Graduate School, Nagoya, 28 November 2019.
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November 28, 2019 Bank of Japan Financial and Settlement Systems as Social Infrastructure: Disaster Management Perspective Opening Remarks at the Symposium "The Impact of Natural Disasters on Financial Markets and Financial Institutions" Held at Nagoya City University Graduate School Masazumi Wakatabe Deputy Governor of the Bank of Japan (English translation based on the Japanese original) I. Introduction I am delighted to be given this opportunity to speak to you at this symposium. Japan is at risk of various natural disasters -- wind and flood damage caused by typhoons or heavy rain, volcanic eruptions as well as earthquakes, such as the Great Hanshin-Awaji Earthquake and the Great East Japan Earthquake. This year again, typhoons such as Faxai and Hagibis inflicted serious damage. The probability that a massive earthquake may occur in the Nankai Trough off the Pacific coast within the next 30 years is estimated to be 70-80 percent. Disaster prevention measures have also been updated in preparation for cases where earthquakes occur consecutively with a certain time lag after the initial event in the Nankai Trough, something which has been experienced in the past. Many other countries seem to be vigilant of the risks of terrorist attacks, cyber attacks, or widespread power outages triggered by transmission equipment malfunction. Growing attention, however, is being paid to natural disasters worldwide. According to statistical data on natural disasters compiled by the Université catholique de Louvain's Center for Research on the Epidemiology of Disasters, the number of cases has recently been in the range of 300350 a year, which is larger than in the past 1 (Chart 1). Although different countries put priority on different risks, climate change risk has increasingly been recognized as a global issue, especially among European countries in recent years.2 This could also be related to unusual weather, including concentrated heavy rains frequently experienced in Japan lately.3 The increase since the 1970s seems to partly reflect an improvement in the accuracy of statistics. Tomohiko Inui, "Shizen saigai to keizai seichō," Keizai Seminā, no. 706, February/March 2019 issue: 25. 2 Growing attention is being given to the impact of climate change on the real economy and financial system among financial supervisory authorities and central banks. This topic has been increasingly discussed at international conferences, including the Network for Greening the Financial System (NGFS). The Bank of Japan announced today (November 28) that it has joined the NGFS. For examples of central banks' initiatives on this issue, see Margherita Giuzio et al., "Climate Change and Financial Stability," Financial Stability Review, May 2019, https://www.ecb.europa.eu/pub/financialstability/fsr/special/html/ecb.fsrart201905_1~47cf778cc1.en.html#toc1; and Lael Brainard, "Why Climate Change Matters for Monetary Policy and Financial Stability," speech at "The Economics of Climate Change," a research conference sponsored by the Federal Reserve Bank of San Francisco, November 8, 2019, https://www.federalreserve.gov/newsevents/speech/brainard20191108a.htm. 3 According to a report compiled by Japan's Ministry of the Environment and others, there is no solid How we should respond to climate change has been discussed from various perspectives thus far, but will be treated as a more practical, more global issue going forward. Looking back at natural disasters in postwar Japan, many severe disasters are called to mind. In particular, Typhoon Vera, also known as the Isewan Typhoon, struck in September 1959, becoming a turning point for Japan in developing disaster countermeasures.4 The extensive damage caused by the Isewan Typhoon led to the Basic Act on Disaster Management, which stipulates the basics underlying Japan's disaster management and control measures, being enforced in 1962 (Chart 2). In response to this, the Bank of Japan formulated its disaster management operation plan in 1967. The theme of this symposium is "The Impact of Natural Disasters on Financial Markets and Financial Institutions." Today, I would firstly like to describe the Bank's role and function in the context of Japan's disaster management, and then, referring to past actions, talk about the importance of maintaining "financial and settlement systems as social infrastructure" in times of disaster. In normal times, we tend to assume that social infrastructure, such as transportation, water, sewage, electricity, gas, and telecommunication, is naturally available like air. Once a large-scale disaster strikes, however, we become aware that whether such social infrastructure will continue to work or not is critical to our lives. Financial and settlement systems are also part of the social infrastructure. Facing a large-scale disaster, financial institutions play various roles as social infrastructure over time -- from the recovery phase to the reconstruction phase, for example (Chart 3). In the next part, I will first elaborate on the expected roles of financial institutions shortly after a disaster strikes. Moreover, disaster management can be considered as a cycle of actions. The cycle is comprised of two parts: (1) post-disaster actions for minimizing the spread and prolongation evidence that the frequency and strength of cyclones have increased in the long run, except for the North Atlantic. Ministry of the Environment et al., Kikō hendō no kansoku yosoku oyobi eikyō hyōka tōgō repōto 2018: Nihon no kikō hendō to sono eikyō [Synthesis report on observations, projections and impact assessments of climate change, 2018: Climate change in Japan and its impacts] (February 2018): 54, http://www.env.go.jp/earth/tekiou/report2018_full.pdf. 4 Dead or missing nationwide totaled over 5,000 people. Particularly serious damage was experienced in Aichi, Mie, and Gifu Prefectures due to storm surge. of damage and (2) pre-disaster actions for preventing damage and forecasting future disasters based on lessons from the past. It is important to view these two parts as an interrelated sequence, or a cycle (Chart 4).5 Toward the end of this talk, I would like to describe disaster management from this perspective. II. The Bank of Japan as a Designated Public Institution The Bank is listed as a designated public institution in the Basic Act on Disaster Management, together with the Japanese Red Cross Society and electric power companies, for example. Along with the national and local governments, designated public institutions are required to make necessary arrangements to protect "the lives, bodies, and property of citizens from disaster." The Bank not only issues banknotes and conducts monetary policy, but also provides a system to settle funds smoothly among financial institutions. For example, let's consider the situation, shown in Chart 5, where you pay for goods and services by a bank transfer from your account at Bank A to the merchant's account at Bank B. Transaction information, such as the amount of transferred funds and the payee's account number, is notified to Bank B through the Zengin System, a nationwide online network system for banks. The net settlement position is calculated for each financial institution and notified to the Bank of Japan Financial Network System (BOJ-NET). Funds are then settled through financial institutions' current accounts at the Bank. In a situation where a firm makes a bank transfer for salary payment from its account at Bank B to your account at Bank A, funds are settled in the opposite direction. The Zengin System is affiliated with the Japanese Bankers Association, and the Bank monitors such major private payment and settlement systems at all times to ensure their stable operation. The BOJ-NET is a system developed and operated by the Bank, settling funds among financial institutions while preparing for various risks. The Bank prepares for necessary business continuity, aiming at fulfilling its mission of ensuring stable operation of payment and settlement systems in addition to issuing banknotes even in times of disaster. Cabinet Office, "Heisei 17-nen-ban bōsai hakusho" [White paper on disaster management 2005], 2005, http://www.bousai.go.jp/kaigirep/hakusho/h17/bousai2005/html/honmon/hm140106.htm. III. Experience of the Great East Japan Earthquake What would you do if a severe earthquake strikes and an alert warning of massive tsunamis is issued a few minutes later? Those who are near the coast would evacuate to higher ground immediately with the bare minimum of belongings. What would you do if you return home after the tsunami recedes and find your cash muddy or burnt and stuck together at home? What if your passbooks or registered seals are washed away by the tsunami? What if your payday is next week but the bank branch at which you have an account is swept away by the tsunami? When the Great East Japan Earthquake struck in 2011, these problems actually occurred extensively in the affected areas, causing anxiety for many people. At that time, financial institutions in the affected areas themselves were damaged, but continued to make strenuous efforts to fulfill their mission. To help us consider today's topic, let me briefly look back on the financial institutions' actions at the time.6 1. The Bank of Japan's Experience At 2:46 p.m. on March 11, 2011, the Bank's Sendai Branch experienced a strong quake. Objects fell from the ceiling and the branch was shrouded in haze created by dust. When the quake finally subsided, a voice resounded in the branch, "The BOJ-NET is functioning properly." Triggered by this call, the staff resumed their work to continue business operations. Financial institutions make massive fund transfers with each other via the BOJ-NET every day.7 If you compare money to the blood of Japan's economy, the shutdown of the BOJ-NET means the absence of blood flow in the economy. The Bank made the following responses at the time. Firstly, 15 minutes after the earthquake occurred, it set up a disaster management team headed by the Governor. The team gathered information concerning the damage, coordinated with government and other relevant parties, and disseminated information domestically and internationally on the operational status of the Bank's offices and financial markets. Bank of Japan Payment and Settlement Systems Department, "Higashi Nihon Daishinsai chokugo no kin'yū kessai-men no dōkō: Dēta ni motozuku jijitsu seiri," BOJ Reports & Research Papers, March 2013, http://www.boj.or.jp/research/brp/ron_2013/data/ron130311a.pdf. 7 The value of fund transfers settled via the BOJ-NET were about 150 trillion yen on average every business day in fiscal 2018. As March 11 was a Friday, the Bank's branches and offices in the affected Tohoku region continued to supply cash to financial institutions by opening service counters during the weekend. This was to meet the increased cash demand because, once a disaster occurs, people seek to hold more cash on hand out of a need to secure funds for immediate living expenses and out of fears about the future. In times of disaster, demand for cash tends to increase sharply as it performs the two-fold functions of money: a medium of exchange (i.e., a means of payment) and a store of value.8 A few days after the disaster, a massive amount of damaged banknotes and coins were brought to the Bank to be exchanged for clean ones. The Bank met these requests by sending staff from other parts of Japan to help branches in the affected areas. In Iwate Prefecture, where the Bank does not have a branch, we set up a temporary counter at a local financial institution to provide the exchange service. The Bank delegates some services to private financial institutions to make payments for public pensions and government workers' salaries, as well as to provide services related to receipts and payments of treasury funds, including receipts of taxes. Since many of the delegated agents, or financial institutions' locations, were also damaged at the time,9 the Bank itself took over part of the work that was delegated to them. A timely response was required, partly because the payday for self-defense officers involved in relief and rescue operations in the region was scheduled in the week after the disaster. With regard to payment and settlement systems, the BOJ-NET continued to operate in a stable manner without a halt even during the time of the disaster. The Bank also continued to monitor the operational status of the payment and settlement systems run by private organizations, working in cooperation with them as necessary to effect smooth settlement of transactions, including salary payments, which increased toward the end of the month. Strictly speaking, money also functions as a measure of value. Of the 40 agents in the Tohoku region, 16 became temporarily unable to continue business operations. 2. Impact on financial institutions and their response Let me turn to the impact on financial institutions in the affected areas immediately after the disaster. As of March 14, about 280 locations were closed following the evacuation order in response to the tsunamis and the nuclear accident. This was more than 10 percent of all the locations of the 72 financial institutions headquartered in one of the six prefectures of the Tohoku region or Ibaraki Prefecture. This fact alone is enough to tell you that financial institutions found themselves in a difficult situation along with the affected population. How did financial institutions fulfill their roles as social infrastructure in this situation? Let us look back on their actions in details. First, financial institutions in the affected areas sought to secure more abundant cash on hand than usual immediately after the disaster to meet increased cash demand from affected customers. These institutions withdrew cash from their current accounts at the Bank and delivered it to their headquarters and branches in the affected areas. Since there were traffic network disruptions and restrictions as well as a lack of cash-delivery vehicles, financial institutions in neighboring areas sometimes shared them. On the back of such actions, cash totaling about 310 billion yen was withdrawn from the Bank by financial institutions in the Tohoku region during the first week after the disaster. This is about three times the amount in the same period in the previous year. Financial institutions conducted their business in a flexible manner to enable affected customers to withdraw their deposits as long as their identification was confirmed, even if they had lost their passbooks or registered seals. This response incorporated requests made by the Financial Services Agency and the Bank to financial institutions to treat affected people favorably.10 Disaster victims who had lost passbooks or other relevant documents were able to withdraw close to 6.0 billion yen from financial institutions by April 2011, even in the three affected prefectures alone (Chart 6). Moreover, when those affected brought waterlogged or burnt cash to financial institutions, they were able to exchange it for new cash. Damaged cash brought in by financial institutions and disaster victims was also exchanged at In general, the Financial Services Agency and the Bank make a decision on whether to put such requests forward to financial institutions each time the Disaster Relief Act is applied to the affected areas. the Bank's service counters, the amount reaching 470,000 banknotes (3.5 billion yen) and 4,220,000 coins (0.14 billion yen) by March 2012 (Charts 7 and 8). Even when financial institutions found it difficult to restore their affected branches, they remained available for affected depositors as much as possible by, for example, setting up temporary locations. Among the bank locations closed immediately after the disaster, about 40 percent resumed business by the end of March. During that time, 41 temporary locations were also set up (Charts 9 and 10).11 Meanwhile, the BOJ-NET and core payment and settlement systems in the private sector maintained stable operations as a whole. Even at the end of March, when there was a concentration of a large number of payments for salaries, public utility services, and others, there was no serious disruption in payments and settlements in the affected areas. Behind the scenes, the Zengin System, which processes transfer data, and the BOJ-NET extended operating hours for consecutive days to complete as many scheduled transactions as possible within the day.12 In addition, various other measures were taken to maintain the clearing function of financial institutions. They include some clearing houses covering the work of other clearing houses which had had to be closed due to damage to their buildings or other reasons. At the time of the Great East Japan Earthquake, foreign media often reported that Japan's public order was maintained even in an extreme situation. 13 I believe that ensuring the payment and settlement functions of financial institutions as well as the circulation of cash on the whole contributed to social stability in the affected areas. In addition, some financial institutions organized information-sharing arrangements among themselves so that affected persons who evacuated to distant locations would be able to withdraw cash at financial institutions other than those where they have accounts. 12 A system failure at a financial institution on March 14 significantly delayed its submission of transfer instructions to the Zengin System. The Zengin System and the BOJ-NET dealt with the situation by extending their operating hours. 13 Nicholas Kristof, "Sympathy for Japan, and Admiration," New York Times, March 11, 2011, https://kristof.blogs.nytimes.com/2011/03/11/sympathy-for-japan-and-admiration/. Kyung Lah, "Amid Disaster, Japan's Societal Mores Remain Strong," CNN, April 10, 2011, http://edition.cnn.com/2011/WORLD/asiapcf/03/16/japan.cultural.order/index.html. 3. Developments in financial markets and policy response The Great East Japan Earthquake also had a significant impact on financial markets. When uncertainty about the future heightens due to a disaster or other reasons, financial institutions and firms seek more proactively to secure cash on hand, or liquidity. This is similar to households increasing their cash demand after the earthquake as I mentioned earlier. In response to such developments, the Bank judged that it had to take all possible measures to relieve concern about funding immediately and ensure financial market stability. It provided funds totaling a record high of 21.8 trillion yen through funds-supplying operations on March 14, the first business day after the earthquake. The Bank continued to offer sameday funds-supplying operations for six consecutive business days through March 22 (Chart 11). With the Bank's provision of ample funds, there was no notable turbulence in money markets, where financial institutions lend and borrow funds with each other. The Bank also decided on April 28, just about a month after the disaster, to introduce the funds-supplying operation to support financial institutions in disaster areas. Although this was quite some time before funding needs for recovery and reconstruction gained momentum, the Bank aimed to make funding by financial institutions easier there both in the initial and subsequent phases after the disaster. Meanwhile, looking at the developments in the stock and foreign exchange markets, the Nikkei Stock Average, for instance, declined sharply as the damage became apparent, eventually falling by 1,015 yen, or 10.6 percent on March 15 from the previous business day (Chart 12). This rate of decline is still the third largest in history, following only those recorded on Black Monday in 1987 and after the Lehman Brothers failure in 2008. In the foreign exchange market, amid the yen's appreciation, concerted foreign exchange market intervention was conducted by the authorities of Japan, the United States, the United Kingdom, Canada, and the European Central Bank on March 18. IV. Initiatives after the Great East Japan Earthquake Over eight years have passed since the Great East Japan Earthquake. Based on lessons from the disaster, initiatives to enhance disaster management have been taken at various levels from Japan's government to individual firms, and are still under way. Financial institutions have also enhanced their disaster management programs, as can be summarized in the following three points (Chart 13). The first is self-help initiatives. Many financial institutions faced risks of a power shortage and traffic network disruptions at the time of the earthquake. Such experiences highlighted the importance of having backup arrangements for computer systems and headquarters' functions at places remote from their headquarters -- for example, in Osaka when the headquarters is in Tokyo -- in order to maintain the payment and settlement functions even in times of disaster. In fact, financial institutions have striven to set up such sites and enhance their functions. Recently, an increasing number of financial institutions have introduced dual operation, under which not only main offices but also backup offices conduct part of their business operations even in normal times.14 The second is mutual assistance initiatives. Financial institutions have recognized that, given the expected magnitude of damage by a possible Nankai Trough Earthquake or other disasters, an individual institution alone cannot make adequate preparations, or even if it tries, it will be too costly compared to their management resources. Some of these financial institutions created regional councils, making arrangements where participating financial institutions will provide needed cash to each other in times of disaster. On the level of financial markets, including money markets, securities markets, and the foreign exchange market, initiatives have been pushed forward to enhance the framework of a market-level business continuity plan (BCP). This will enable financial institutions participating in the market to immediately share their damage situation and, based on that assessment, discuss possible changes to trading practices for the market to function smoothly.15 According to a survey conducted by the Bank in May 2019, close to 80 percent of the financial institutions with backup offices in Osaka responded that they had introduced dual operation for some business in normal times. 15 The market-level BCP is a framework for participants in money markets, securities markets, and the foreign exchange market to share information and cooperate when disasters disrupt normal market management, with a view to maintaining or quickly recovering the functioning of markets. The third is public assistance initiatives. Since the Great East Japan Earthquake, Japan's national and local governments have revised upward their estimation of damage that can be caused by possible large-scale earthquakes, floods due to heavy rains, and other disasters, and have also updated hazard maps. This imposed challenges on financial institutions, especially those located near the coast, but it added momentum to the progress of detailed considerations and preparations from the viewpoint of business continuity and employee safety. Specific measures based on local circumstances have also been advanced; for example, the improvement of priority roads that are supposed to be restored sooner as well as the registration of emergency vehicles -- both of which will be useful for cash delivery in times of disaster. Meanwhile, the Bank introduced a framework enabling financial institutions to receive cash from another nearby branch of the Bank when a branch of the Bank or an office of a financial institution which has a current account at a branch of the Bank is affected.16 V. Continuous Review and Enhancement of Business Continuity Arrangements Of all the financial institutions in Japan, how many have already prepared business continuity arrangements? According to the Bank's survey in 2014, 85 percent of the financial institutions, including banks and securities companies, answered that a companywide business continuity management framework had already been put in place and regularly reviewed.17 Financial institutions run their businesses while assessing various risks such as the credit risk of borrowers and market risk associated with bond holdings. Operational risk, including that for computer system failures, also needs to be considered, and therefore, upgrading business continuity arrangements is an important managerial issue in disaster preparation. Given this, financial institutions take it for granted that such arrangements should be in place, but there is also a need to advance them further. From my perspective, with a view to serving as social infrastructure even in times of disaster, three things are expected of financial institutions going forward (Chart 14). Each contributes to the enhancement of resilience against disasters -- that is, the capability to minimize the damage, achieve prompt recovery, and continue business operations. http://www5.boj.or.jp/hakken/hatsu1809.pdf. Bank of Japan Financial System and Bank Examination Department, "Questionnaire Survey on Business Continuity Management (September 2014)," Paper Series on Risk Management in Financial Institutions, May 2015, https://www.boj.or.jp/en/research/brp/ron_2015/data/ron150515a.pdf. The first is to enhance disaster preparedness. Referred to as the "6 Ps" -- Proper Planning and Preparation Prevents Poor Performance -- it is essential to repeatedly review and improve business continuity arrangements by taking the opportunities of coping with actual disasters and by conducting periodic emergency drills. The Bank practices an emergency drill every September, involving its disaster management team headed by the Governor. We have continued to update the way it is conducted, for instance, by implementing the drill scenarios, including the details and extent of damage, without advance disclosure to the participants, but presenting them with the information on the spot. To improve our existing business continuity arrangements, we have reflected on lessons learned from each drill. It is essential for each financial institution to get their business continuity framework entrenched in its organization and keep working toward increasing its feasibility in times of disaster by, for example, updating the content of emergency drills and reviewing their experience under management leadership. The second is to enhance inter-organizational cooperation. When a disaster strikes, controlling the damage is key. In this connection, cooperation among related organizations matters to minimize the impact of the damage and achieve a swifter recovery. One option is to build relationships in normal times with local governments, financial institutions, utility firms as well as monetary authorities, including the Bank's branches, to be able to cooperate in times of disaster as necessary. It is also important to confirm that there is no significant gap with the counterparts in their business continuity arrangements and assumed emergency situations. The third is to enhance flexibility and imagination. Changes in circumstances and the emergence of new risks take place constantly. As I mentioned earlier, climate change risk has been increasingly recognized worldwide. Moreover, although it is not a natural disaster, we have also observed increasing cyber security threats on a global scale in recent years. In the financial sector, cyber drills are conducted both at an international level, such as under the G7 framework, and at a domestic level, among financial institutions. National governments have also taken the lead in developing cyber countermeasures. 18 Such cyber security For a work that raised alarms over cyber risk, see David E. Sanger, The Perfect Weapon: War, Sabotage, and Fear in the Cyber Age (London: Scribe, 2018). Principles for regulatory response to measures have become even more important with the increasing use of mobile payments. Japan's national and local governments may revise their disaster damage estimation again in the future, and public expectations of services provided by social infrastructure may also change. It is vital to pay due attention to changes in circumstances and the emergence of new risks, reviewing with flexibility and a fertile imagination to see whether there is any room for improvement in business continuity arrangements. VI. Concluding Remarks Thus far, my discussion has focused on the role of financial institutions in times of disaster, while looking back on their response to the Great East Japan Earthquake. In times of disaster, it is critical that financial institutions ensure cash circulation and maintain their payment and settlement functions as social infrastructure underpinning financial and economic activities. Even if we are prepared for disasters, we are often required to take different measures in times of actual disaster. After a disaster winds down, it is essential to reflect on the experience, serving as a starting point toward more advanced preparation for possible future disasters. In this sense, risk and crisis management never ends.19 I heard that the Central Japan Economic Federation published a report on the current situation and challenges of the social infrastructure in preparation for the Nankai Trough Earthquake, one of the anticipated natural disaster risks particularly feared in this region. 20 I expect financial institutions to further advance the reviews of disaster management and actions to cyber risk are proposed mainly from the perspective of macroprudential policy in Anil K. Kashyap and Anne Wetherilt, "Some Principles for Regulating Cyber Risk," AEA Papers and Proceedings 109 (2019): 482-87. For the Bank's publications, see: Shigehiro Kuwabara, "Kin'yūshijō infura to saibā rejiriensu," remarks at Dai-18-kai Kessai Shisutemu Fōramu, February 6, 2018, https://www.boj.or.jp/announcements/press/koen_2018/ko180206a.htm/; and Bank of Japan Financial System and Bank Examination Department, "IT no shinpo ga motarasu kin'yū sābisu no aratana kanōsei to saibā sekyuritī," Financial System Report Annex Series, March 2016, https://www.boj.or.jp/research/brp/fsr/data/fsrb160302.pdf. 19 There are similarities between natural disaster management and financial and economic crisis management. See PHP Research Institute, Nihon no kikikanri-ryoku, ed. Masazumi Wakatabe (Tokyo: PHP Institute, 2009). 20 Central Japan Economic Federation, "Nankai Torafu Jishin tō ga Chūbu keizaikai ni ataeru eikyō o saishōka suru tameni: Torimaku shakai infura no genjō to kadai (Aichi-ken o moderu to shita kēsu sutadī)," May 2019, http://www.chukeiren.or.jp/policy_proposal/pdf/190517_Nankai_Teigen.pdf. ensure the safety of their employees and play the necessary roles in their respective business areas. The Bank will continue to provide firm support for their efforts. Let me close my presentation by citing a brief episode I heard about. After the Great East Japan Earthquake, a student found muddy banknotes in a chest of drawers at the back of a room, when he, as a volunteer, helped an affected family to clean up their house after being flooded by the tsunami. The student visited a branch of the Bank with the family, and they had the muddy banknotes exchanged for clean, new ones. The student now works at the Bank. It is among the missions of the Bank to make sure that cash will be provided and circulated even in times of disaster. Thank you for your kind attention. Financial and Settlement Systems as Social Infrastructure: Disaster Management Perspective November 28, 2019 The Symposium "The Impact of Natural Disasters on Financial Markets and Financial Institutions" Held at Nagoya City University Graduate School Masazumi Wakatabe Deputy Governor of the Bank of Japan Number of Natural Disasters World Chart 1 Japan Note: Excludes biological disasters such as epidemic diseases. Source: EM-DAT: The Emergency Events Database - Université catholique de Louvain (UCL) - CRED, D. Guha-Sapir www.emdat.be, Brussels, Belgium. Chart 2 Past Disasters and Development of Related Laws 1950- September 11 attacks Isewan Typhoon Disasters in Japan and abroad The Mid Niigata Prefecture Earthquake Outbreak of a new strain of influenza Great HanshinAwaji Earthquake Basic Act on Disaster Management Enforcement of laws Civil Protection Law Act on Special Measures Concerning Countermeasures for Large-Scale Earthquakes Disaster management operation plan Bank of Japan's response Great East Japan Earthquake Kumamoto Earthquake Act on Special Measures Concerning Countermeasures for Tokyo Inland Earthquake Amendment of the Act on Special Measures Concerning Countermeasures for Nankai Trough Earthquake Act on Special Measures Concerning Countermeasures for Novel Influenza, etc. Civil protection business plan Operational plans for dealing with pandemic influenza and new infectious diseases Chart 3 Phases of Post-Disaster Actions National and local governments Restoring roads, facilities, etc. Rescuing human lives, etc. Disaster Emergency responses Ensuring safety and business continuity (cash circulation, payment and settlement functions), etc. Formulating reconstruction plans, taking budgetary measures, etc. Recovery Resuming operations, providing financial services (emergency loans) in consideration of disaster situations, etc. Reconstruction Supporting reconstruction (through consulting services), arranging public-private partnerships, etc. Financial institutions Chart 4 Disaster Management Cycle Pre-disaster actions Post-disaster actions Disaster Emergency responses Preparedness Recovery & Reconstruction Prevention & Mitigation Source: Prepared based on Cabinet Office, "Heisei 17-nen-ban bōsai hakusho" [White paper on disaster management 2005], 2005, http://www.bousai.go.jp/kaigirep/hakusho/h17/index.htm. Chart 5 Process of Payment and Settlement and Role of the Bank of Japan Sales transaction Consumer Firm Provision of goods and services Request for fund transfer Bank A Transfer message Transfer message Zengin System Consumer's deposit account Notification of fund transfer Bank B Firm's deposit account Notification of net settlement position BOJ-NET Fund transfer Bank A's account held at BOJ Fund transfer Zengin-Net's account held at BOJ Bank B's account held at BOJ Cash Withdrawals by Depositors Who Lost Passbooks Chart 6 Note: Figures are cumulative and for regional banks (I and II) and shinkin banks headquartered in Iwate, Miyagi, or Fukushima Prefectures that were able to respond (3 regional banks I, 1 regional bank II, and 8 shinkin banks). Source: Bank of Japan. Chart 7 Examination of Damaged Banknotes and Coins for Exchange First, muddy banknotes brought to the Bank are washed. The banknotes are then dried one by one using hairdryers, etc. Chart 8 Examination of Damaged Banknotes and Coins for Exchange Finally, the dried banknotes are laid out and examined. Similarly, coins are washed and examined. Chart 9 Number of Bank Locations Closed Note: Figures for financial institutions headquartered in one of the six prefectures of the Tohoku region or Ibaraki Prefecture. The total number of locations is about 2,700 of 72 financial institutions. Source: Financial Services Agency. Chart 10 Number of Temporary Bank Locations Opened (Number of locations) Note: Figures are for regional banks (I and II) and shinkin banks headquartered in Iwate, Miyagi, or Fukushima Prefectures that were able to respond (3 regional banks I, 4 regional banks II, and 18 shinkin banks). Source: Bank of Japan. Chart 11 Developments in BOJ Current Account Balances before and after the Disaster March 11, 2011→ Bank of Japan provided funds totaling a record high of 21.8 trillion yen on March 14. Source: Bank of Japan. Chart 12 Developments in Stock Prices and Exchange Rates before and after the Disaster March 11, 2011 → Source: Bloomberg. Initiatives Based on Lessons from the Great East Japan Earthquake Chart 13 1. Self-help → Many financial institutions have recognized the importance of backup arrangements for computer systems and headquarters' functions, striving to enhance them. 2. Mutual assistance → Arrangements for mutual cooperation (in providing cash, etc.) among financial institutions and market-level frameworks have been made and enhanced. 3. Public assistance → Consideration on business continuity has progressed, partly reflecting upward revisions of disaster damage estimation by national or local governments. Chart 14 What is expected of Financial Institutions 1. Enhancement of disaster preparedness → Continue to review business continuity arrangements to increase feasibility by taking the opportunity of coping with actual disasters and conducting periodic emergency drills. 2. Enhancement of inter-organizational cooperation → Build relationships in normal times with local governments, financial institutions, firms, and monetary authorities so that they can cooperate as necessary in times of disaster. 3. Enhancement of flexibility and imagination → Pay attention to changes in circumstances and new risks, reviewing with flexibility and a fertile imagination to see if there is any room for improvement in arrangements.
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Speech by Mr Masazumi Wakatabe, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Ehime, 5 February 2020.
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February 5, 2020 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Ehime WAKATABE Masazumi Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Good morning. 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 chance to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's Matsuyama Branch. At the Monetary Policy Meeting held in January, the Bank updated its projections for Japan's economic activity and prices through fiscal 2021 and released them in its quarterly Outlook for Economic Activity and Prices (Outlook Report). Today, while outlining the Outlook Report, I would like to explain the Bank's view on developments in economic activity and prices, including the global economy, as well as monetary policy conduct, with a focus on economic growth. I. Financial and Economic Developments A. Developments in the Global Economy Let me start by talking about developments in the global economy. The growth rate of the global economy has decelerated since around mid-2018, and according to the latest forecasts released by the International Monetary Fund (IMF), the global growth rate for 2019 likely was slightly below 3 percent for the first time in 10 years (Chart 1). The recent slowdown in the global economy was triggered by a rapid deceleration in manufacturers' activities on a global basis, mainly due to a heightening of uncertainties over the U.S.-China trade friction and adjustments in the cycle for IT-related goods that were affected by weak demand, such as for smartphones (Chart 2). A heightening of uncertainties also has led to the postponement of business fixed investment, with the world trade volume, mainly in IT-related goods and capital goods, decelerating significantly. However, while relatively large adjustments have been seen in the manufacturing sector, the nonmanufacturing sector has been steady on a global basis. This contrast between the manufacturing and nonmanufacturing sectors sometimes is called "decoupling." There are some factors behind the global decoupling. First of all, the employment and income situation has been favorable in many countries. In addition, each country strengthened monetary and fiscal measures in response to the heightening risks of the economic slowdown. As a result, accommodative financial conditions, tight labor market conditions, and steady consumer sentiment have been maintained, supporting domestic demand in each country even with the deceleration in the manufacturing sector. That said, there is no guarantee that this decoupling will last for a long time. If the slowdown in the manufacturing sector becomes prolonged, its impact could spread gradually to the nonmanufacturing sector and households. In contrast, if adjustments in the manufacturing sector mostly come to an end while domestic demand remains resilient, the global economy is expected to return to a growth path. On this point, the Bank considers it highly likely that the latter scenario will be realized -- that is, the global economy will pick up gradually. Let me point out two factors that are the basis for the realization of this scenario. The first is that there has been some progress in dealing with the problems that were at the root of the global uncertainties, such as the U.S.-China trade negotiations and the United Kingdom's exit from the European Union (EU). If overall uncertainties wane to some degree in reflection of such progress, firms are likely to take more positive actions, although the Bank judges that uncertainties regarding the global economy are still significant, as I will talk about later. The second is that adjustments in the global manufacturing sector have progressed and business sentiment has improved (Chart 3). In the IT-related sector in particular, inventory adjustments have progressed globally and world semiconductor shipments have picked up. As for the outlook for this sector, demand related to data centers and the 5G network is expected to increase, thereby pushing up production activity. The Bank's projection is consistent with those presented by international organizations. For example, in the IMF's World Economic Outlook Update, the global growth rate is projected to rise from 2.9 percent for 2019 to 3.3 percent for 2020 (Chart 1). B. Current Situation of and Outlook for Japan's Economy Next, I will turn to economic developments in Japan. The slowdown in the growth pace of the global economy also has affected Japan's economy, mainly through somewhat weak external demand. Reflecting this slowdown and such effects as of the consumption tax hike and natural disasters, Japan's economy seems to have briefly registered a significant deceleration in the October-December quarter of 2019. However, the Bank considers at this point that such deceleration is temporary and that Japan's economy has been on a moderate expanding trend. This is based on the assessment that the trend in the three pillars of domestic demand -- business fixed investment, private consumption, and government spending -- has been firm. Let me elaborate on this. I will first talk about business fixed investment. In Japan, it has continued on an increasing trend (Chart 4). Some manufacturers have postponed investment intended for capacity expansion due to the slowdown in overseas economies; so far, however, construction investment has continued to increase and there has been no change in firms' efforts toward making strategic investment from a long-term perspective. As for the outlook, the Bank projects that these investments will continue to increase. Regarding construction investment, in Japan, buildings and structures have been aging in reflection of long-lasting weak construction investment since the bubble burst in the early 1990s, and potential replacement demand seems to be high. Such potential demand is likely to underpin construction investment for a long time in a situation of accommodative financial conditions. In addition, labor-saving investment in view of demographic changes is expected to continue increasing, and IT investment seems to be gradually becoming active in a wide range of sectors recently, including investment related to big data, artificial intelligence (AI), and the Internet of Things (IoT) that aims at creating new businesses, expanding sales channels, and promoting use for marketing.1 Next, let me move on to private consumption (Chart 5). For the time being, the effects of the October 2019 consumption tax hike warrant attention. On this point, private consumption for the October-December quarter declined considerably, but it should be noted that this decline is attributable to such factors as natural disasters. Looking at developments in private consumption excluding these special factors, the impact of the tax hike so far is assessed as being smaller than that of the previous tax hike in 2014. However, uncertainties regarding the 1 See Box 3 "Background to the Recent Steady Business Fixed Investment" in the January 2020 Outlook Report. impact of the tax hike are still significant and are considered one of the risks in assessing future economic activity. I will touch on this point again later. Lastly, let me explain developments in government spending. In recent years, there have been successive natural disasters in Japan.2 At the end of last year, the government formulated the economic measures for the first time since 2016, with the aim of overcoming natural disasters and downside risks to economic activity and of providing people with a sense of security for the future. Owing to the implementation of various measures in this economic package, government spending, such as on public construction, is expected to continue increasing for the time being (Chart 6). Moreover, I think that flexible conduct of fiscal policy in response to economic developments amid a situation where the Bank continues to conduct a largescale monetary easing will enhance the synergy effects of monetary easing and fiscal stimulus, thereby further strengthening economic stimulus effects. Generally speaking, in the case where a government expands its spending through increased issuance of government bonds, the mechanism will operate in which upward pressure on longer-term market rates emerges and gradually restrains such items as private investment. On the other hand, in the case where a central bank restrains a rise in market rates even amid an expansion in government spending, the negative impact on private investment will be limited and stronger economic stimulus effects are expected.3 In sum, the underlying trend in domestic demand has been firm thus far and it is expected to follow an uptrend. In the Bank's January 2020 Outlook Report, also taking into account that overseas economies are likely to pick up gradually, Japan's real GDP growth rate is projected to be 0.8 percent for fiscal 2019, gradually rising to 0.9 percent for fiscal 2020 and 1.1 percent for fiscal 2021 (Chart 7). 2 Wakatabe, M., "Financial and Settlement Systems as Social Infrastructure: Disaster Management Perspective," opening remarks at the symposium titled "The Impact of Natural Disasters on Financial Markets and Financial Institutions" held at Nagoya City University Graduate School, November 28, 2019, http://www.boj.or.jp/en/announcements/press/koen_2019/ko191225a.htm/. 3 See Box 1 "Policy Mix Effects" in the January 2020 Outlook Report. C. Risk Assessments However, there are uncertainties regarding this baseline scenario, and I would like to underline the need to closely monitor the downside risks at present. The first risk factor is developments in overseas economies. Although the United States and China reached an agreement on the initial trade deal, there remain many deep-rooted conflicts between the two countries. Attention also should be paid to geopolitical risks surrounding developments in the Middle East. Recently, there have been heightening uncertainties regarding the impact of the spread of the novel coronavirus on the global economy. An indicator that captures global policy uncertainties mainly through the number of news reports has remained at a high level (Chart 8). Taking these developments into account, it is necessary to closely examine whether the scenario will be realized in which firms' activities will become more active through a decline in uncertainties, and in turn trade activity and business fixed investment also will pick up. The second risk factor is developments in domestic demand. The effects of the consumption tax hike on household spending can be divided into two: (1) an increase in demand prior to the tax hike and a reactionary decline and (2) a decline in households' real income due to the tax hike. The former seems to have been constrained this time compared to those of the previous tax hike, partly due to the government's various policy measures (Chart 9). On the other hand, the effects of the latter could materialize gradually through, for example, changes in households' spending attitudes -- that is, the propensity to consume. This time, compared with the previous tax hike, the increase in the net burden on households due to the tax hike has been constrained owing to various support measures and growth in employee income has been maintained, and both factors are likely to underpin real income. Looking at indicators of consumer sentiment that can capture households' spending attitudes relatively early, these continued to show some weakness before the tax hike, whereas there seems to have been a pick-up to some extent after the tax hike, mainly led by the category of "overall livelihood" in the Consumer Confidence Index (Chart 10). However, it is too early to make an assessment on households' spending attitudes at this point, and we would like to carefully examine additional data when they become available. II. Price Developments Next, I will explain price developments (Chart 11). A sustained decline in prices continued in Japan for many years. In order to overcome this situation, the Bank introduced quantitative and qualitative monetary easing (QQE) in 2013 and has pursued a large-scale monetary easing since then. Subsequently, the economy has improved significantly and the year-on-year rate of change in the consumer price index (CPI) has taken hold in positive territory. Thus, Japan's economy already is no longer in deflation in the sense of a sustained decline in prices. The year-on-year rate of change in the CPI currently is at around 0.5 percent, and this level is still lower than the price stability target of 2 percent set by the Bank. Although there are some factors that have been pushing down prices, firms' moves to reflect upward pressure stemming from such items as personnel expenses and shipping costs in selling prices have continued, albeit gradually. The Bank expects that the annual CPI inflation will continue to increase gradually (Chart 12). The rates of increase in wages and employee income are likely to accelerate gradually, as the labor market conditions are expected to remain tight with the economy continuing to expand. Consequently, it is likely that households will accept price rises more easily and firms will be able to further raise their selling prices accordingly. If wages and prices continue to rise, people's inflation expectations will increase, leading to a moderate rise in actual prices. It is projected in the latest Outlook Report that, with this mechanism operating, the year-on-year rate of change in the CPI excluding fresh food will be 0.6 percent for fiscal 2019, gradually rising to 1.0 percent for fiscal 2020 and 1.4 percent for fiscal 2021. However, this baseline scenario of the outlook for prices entails downside risks. Under the current situation in particular, it is necessary to take into account the possibility that downside risks to economic activity may materialize and affect prices. Therefore, the Bank will continue to carefully examine economic and price developments and monitor whether the mechanism will be maintained in which the inflation rate increases toward the price stability target of 2 percent. III. Discussions over Japanification and Economic Growth A. What is "Japanification"? Lately, the term "Japanification" of advanced economies has come to be used frequently.4 While it does not really have a clear definition, it often is used to explain the following situation. In advanced economies, the economic growth rates, the inflation rates, and interest rates declined after the global financial crisis, and this situation has been lasting. As the situation of low growth, low inflation, and low interest rates becomes prolonged, the economy's potential growth rate becomes lower, protracting low growth, low inflation, and low interest rates for a longer period. Since Japan has experienced this since the 1990s, the term "Japanification" has been used in the context of warning not to follow in Japan's footsteps.5 Chart 13 shows developments in Japan's GDP since 1990 from various perspectives in comparison with other advanced economies. We find the following three points. First, Japan's economic growth rate in terms of nominal GDP clearly has been lower than that of other countries. The nominal GDP growth rate started to decelerate in the first half of the 1990s, and it hardly rose until around 2013. Second, the economic growth rate in terms of real GDP -- which excludes the effects of price fluctuations -- has been at a low level compared to that of other countries, but it is not as low as the nominal growth rate. Third, looking at real GDP per working-age person, Japan's economic growth rate is at around the average level compared to that of other advanced economies. Based on this third point, some argue that Japan's economic growth rate is not that bad and its stagnation, dubbed "Japanification," is exaggerated. However, I would like to stress that At this year's annual meeting of the American Economic Association held in San Diego, California, there was a session titled "Japanification, Secular Stagnation, and Fiscal and Monetary Policy Challenges." For details, see https://www.aeaweb.org/webcasts/2020/japanification-secularstagnation-fiscal-monetary-policy -challenges. 5 Professor Ito at Columbia University defines Japanization -- the other term for Japanification -- by using the following four criteria: (1) the actual growth rate is lower than the potential growth rate for an extended period; (2) the natural real interest rate is below zero and also below the actual real interest rate; (3) the nominal (policy) interest rate is zero; and (4) the economy falls into deflation, i.e., the inflation rate is negative. For details, see Ito, T., "Japanization: Is it Endemic or Epidemic?" NBER Working Paper, no. 21954, 2016. people's perception of economic growth tends to be formed based on nominal figures. One of the reasons why the nominal GDP growth rate was low from the 1990s is that prices continued to decline; in other words, deflation was prolonged. In addition, the unemployment rate went up under deflation. If those unemployed during the "employment ice age" period had been employed, Japan's economic growth rate would have been much higher. B. Importance of Economic Growth Now, I would like to confirm the importance of economic growth. First of all, on average, economic growth leads to improvements in people's living standard as well as nutrition and sanitation levels. Income such as wages, interest, and dividends comes from national output; that is, GDP. Without GDP growth, people's income will not increase. Let me also note that, although many problems have been pointed out regarding GDP, no alternatives have been found easily.6 Second, economic growth brings about employment. In economics, this rule of thumb has long been known as Okun's law. It says that there is a negative correlation between the economic growth rate and (change in) the unemployment rate. This means that, when the economic growth rate rises, the unemployment rate declines accordingly. This relationship is confirmed in Japan (Chart 14).7 Given that unemployment brings about not only a negative impact on the economy but also various human and social costs, it is desirable to maintain a healthy level of employment through economic growth. Third, economic growth allows for various public services to be maintained. A provision of public goods -- such as national defense, police services, the judicial system, social security, 6 Net National Welfare and the Human Development Index, which were advocated as alternatives to GDP in the past, incorporate GDP and income levels. The Social Progress Index is comprised of only social indicators such as the sanitation level and access to education, but these have a close relationship with GDP. 7 Okun's law applies to other advanced economies including the United States. For details, see Ball, L., Leigh, D., and Loungani, P., "Okun's Law: Fit at 50?" Journal of Money, Credit and Banking, vol. 49, issue 7 (2017): 1413-41. medical services, social infrastructure, fundamental education, and basic scientific research -- requires financial resources, the scale of which depends on the size of the economy.8 In reality, there are various challenges to economic growth. For example, environmental pollution and climate change have become global issues. Innovation is essential to reduce the amount of carbon dioxide emissions, and it requires a certain level of research and development (R&D) expenditure. In considering the challenges associated with economic growth, it is important to compare them with the positive effects of such growth.9 C. Declining Population and Economic Growth Let us get back to the situation in Japan. The population has been declining and society is aging. The working-age population and total population marked their respective peaks in 1995 and 2008. The ratio of seniors aged 65 years or older to the total population has continued to rise. Many people doubt that Japan can achieve economic growth in the situation of the declining and aging population. Looking back, people used to be concerned about overpopulation. For example, in the first edition of An Essay on the Principle of Population (1798), Thomas R. Malthus argued that, even though a population increases geometrically, food increases only arithmetically, and thus population growth constrains an enhancement in the living standard per capita. Overpopulation also had been a concern in Japan for a long period until recently.10 In fact, economic growth can be achieved even under a declining population, which might be a headwind for the economy. Taking the case of Ehime Prefecture as an example, gross prefectural product has increased moderately in recent years despite a continuing decline in The following argues that economic growth leads to openness, generosity, mobility, and democracy in a society: Friedman, B. M., The Moral Consequences of Economic Growth (New York: Knopf, 2005). 9 There are arguments that dematerialization has progressed in advanced economies, whereby, despite the economic growth, the consumption of such items as energy and mineral resources as well as the emissions of carbon dioxide have declined. See McAfee, A., More from Less (London: Simon & Schuster, 2019). 10 Tadokoro, M., "Jinkōron no hensen" [Overpopulation or underpopulation?: Japan's discourses on demography in retrospect], Hōgaku kenkyū, vol. 84, issue 1 (January 2011): 63-90. total population in the prefecture (Chart 15). An international comparison shows that there is no correlation between the real GDP growth rate per capita and the population growth rate (Chart 16). Aside from that, there is no correlation between the inflation rate and the population growth rate either. Looking from the supply side, sources of economic growth roughly can be divided into three elements: capital, labor, and knowledge in a broad sense, including technologies and skills. Among these, knowledge is definitely important in achieving economic growth. In the first place, before we use capital and labor, we need a certain level of knowledge to decide what kind of goods and services to produce and consume. Even during the post-war rapid economic growth period in Japan, the contribution of labor input was small while that of capital and knowledge was large (Chart 17). With regard to labor, the current increase in labor force that reflects a decline in the number of unemployed and an increase in labor participation by women and seniors is favorable.11 Compared to a while ago, seniors have become healthier of late. For example, they now are deemed to be physically younger by about 5 years in terms of their average walking speed, and by about 10 years based on their average number of teeth (Chart 18). As for capital, its contribution to economic growth had been low in Japan during the 1990s, but eventually business fixed investment has started to expand in recent years. Knowledge such as people's skills and expertise, science and technology, and education recently has become more and more important for economic growth. This is indicated by the recent increase in investments intended for software as well as research and development. This "knowledge economy" is closely connected to globalization. We tend to think of globalization as the exchange of goods or services, and it is true that economic problems stemming from a declining and aging population can be dealt with, for example, by increasing There is an argument that the unemployment rate has been declining because the working-age population has shrunk due to a declining and aging population. However, in fact, a decline in the unemployment rate has been observed in a situation where labor force has increased since 2013 despite a shrinking in the working-age population. For details, see Wakatabe, M., "Japan's Economy and Monetary Policy," speech at a meeting with business leaders in Aomori, June 27, 2019, http://www.boj.or.jp/en/announcements/press/koen_2019/ko190627a.htm/. imports of labor-intensive goods and tourism. However, we should not forget the fact that globalization also entails the exchange of knowledge. A declining and aging population could affect economic activity not only through simple changes in labor input but also through various other channels.12 It also could have an impact on other factors such as social security.13 Some argue that a declining population leads to a decrease in the number of those engaged in knowledge production, resulting in an end to economic growth.14 Further research about the effects of a declining population on economic growth is still necessary. D. Role of Monetary Policy As stipulated in the Bank of Japan Act, the aim of the Bank's monetary policy is "achieving price stability, thereby contributing to the sound development of the national economy." Of course, economic growth is supported by the growth policies that have an effect on the supply side of the economy. However, discussions over Japanification suggest that monetary and fiscal policies that influence the demand side of the economy and stabilize nominal expenditure also are important in sustaining economic growth.15 See Chart 3 in Wakatabe, M., "Has Japan's Economy Changed?: Challenges and Prospects," speech at the Japan Society in New York, October 3, 2019, http://www.boj.or.jp/en/announcements /press/koen_2019/ko191004a.htm/. 13 With regard to various aspects of population, see Morland, P., The Human Tide: How Population Shaped the Modern World (London: Hodder & Stoughton, 2019). 14 For this argument, see Harding, R., "The Costs of a Declining Population," Financial Times, January 14, 2020; Jones, C. I., "The End of Economic Growth?: Unintended Consequences of a Declining Population," NBER Working Paper, no. 26651, 2020. If the economy is close to the end of economic growth, the role of AI may become more important. For further discussion, see Aghion, P., Jones, B. F., and Jones, C. I., "Artificial Intelligence and Economic Growth" in Agrawal, A., Gans, J., and Goldfarb, A., eds., The Economics of Artificial Intelligence: An Agenda (Chicago: University of Chicago Press, 2019), 237-82. 15 Experience of Japanification poses questions to a variety of dichotomies in economics: nominal and real GDP, the short term and long term, as well as the business cycle and economic growth. An increasing amount of research has been conducted regarding the case where a negative shock of monetary policy could have a long-term negative impact on real GDP if there are hysteresis effects. As one of the research papers that emphasize the hysteresis effects on capital accumulation and technological progress, see Jordà, Ò., Singh, S. R., and Taylor, A. M., "The Long-Run Effects of Monetary Policy," NBER Working Paper, no. 26666, 2020. IV. Economic Developments in Ehime Prefecture Now, let me talk about the economy of Ehime Prefecture. The economy has continued to recover on the whole, although some weakness has been observed in firms' production activities. With regard to business fixed investment, despite being lower than the level of the previous fiscal year, when large-scale investments were undertaken, an active investment stance has been maintained, mainly in investments intended for labor saving, capacity expansion, and research and development. Public investment has increased, mainly led by construction related to restoration and reconstruction following the heavy rains that affected western Japan in July 2018. Private consumption has picked up steadily, albeit with fluctuations due to the effects of such factors as the consumption tax hike. Looking ahead, I would like to focus on how to achieve economic growth with a declining population. In Ehime Prefecture, many efforts have been made to overcome various challenges. For example, in the paper and pulp industry of the prefecture -- which is the second largest in Japan in terms of shipments -- paper-producing firms have made fixed investment aimed at expanding capacity and enhancing labor productivity to meet buoyant domestic and external demand. Firms in the maritime and shipbuilding industries, which form the maritime cluster with numerous relevant firms, have promoted an enhancement of manufacturing capacity and an expansion in fleet capacity. With the aim of enhancing production efficiency, they also have made further efforts in research and development and reinforced inter-firm cooperation to compete with firms abroad. Moreover, as for citrus fruits, of which Ehime Prefecture is the leading producer in Japan, the farming system of the Nanyo area was designated as one of the Japanese Nationally Important Agricultural Heritage Systems, while efforts have been made toward reconstruction following the damage caused by the heavy rains that hit western Japan in July 2018. In the field of nationally famous high-grade citrus, it has produced a new cultivar called Beni Princess and full-scale production is expected. The prefecture also has pushed forward with making highvalue-added products in the primary industry such as in the fishing industry that has the highest output of marine aquaculture products in Japan and in the rice farming industry. For example, the original brand rice of the prefecture called Hime-no-rin has been developed. I have heard that the Research Institute of Agriculture, Forestry, and Fisheries in Ehime Prefecture spent as long as 16 years to develop this brand rice. Tourism is also important in terms of capturing demand from outside the prefecture. Let me take the example of the main building of Dōgo Onsen, which is designated as an important cultural property and a symbol of Dōgo Onsen hot springs. After more than 120 years since the last renovation, conservation repair work in consideration of the future has been underway. Dōgo Onsen has been open for business while being under construction, and I hear that this is the first attempt in the country. Meanwhile, the prefecture has been making various efforts to attract visitors, such as the Dōgo Reborn Project. In addition, regular direct flights between Matsuyama and Taipei were launched last July. Thus, the number of both domestic and foreign visitors to the prefecture has been firm on the whole. Partly because more flights between the two areas are scheduled to start operating this April, the number of visitors is expected to increase further. I hope that the economy of Ehime Prefecture will continue developing further. Conclusion As I mentioned earlier, Japanification has been used as a synonym for low, or negative, inflation and low growth. After the global financial crisis, the inflation rates declined in Europe and the United States, but it is noteworthy that the inflation rate in Japan has turned positive from negative territory since the introduction of a large-scale monetary easing in 2013 (Chart 19). It is true that Japan's inflation rate has not reached the Bank's price stability target of 2 percent and the risk that the economy will fall into deflation again has not been dispelled completely. Given this situation, the Bank has continued with the large-scale monetary easing. Since around last summer in particular, it has clarified its policy stance of being tilted toward monetary accommodation, as downside risks to Japan's economic activity and prices have become significant due to the continued slowdown in the global economy. Since the downside risks are still significant, the Bank, while continuing to carefully examine various risks, will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost. For now, Japanification is a cautionary tale that teaches us to be vigilant so as not to fall into prolonged deflation and low growth, but I hope it will be a success story of Japan overcoming deflation and accomplishing an improvement in the economic growth rate. Speaking of novels associated with Ehime Prefecture, a famous one is Shiba Ryotaro's Saka no ue no kumo (Clouds above the Hill), in which the protagonists are Masaoka Shiki and the Akiyama brothers -- Yoshifuru and Saneyuki -- but he also wrote a historical novel called Date no kurofune (Date's Black Ship). This is the story of a poor craftsman, Kazō (named Maebara Kōzan afterward), who lived in the Uwajima clan at the end of the Edo period, passionately taking in knowledge from overseas and succeeding in building a steamship only five years and seven months after the arrival of Commodore Perry's black ships. Kazō was so talented that the founder of Japan's modern army, Murata Zōroku (named Ōmura Masujirō afterward), who worked with Kazō to build the steamship, is said to have mentioned that he could be a professor at a university if he lived in Europe. I think Kazō's life is a guide for the path that Japan should take toward achieving economic growth -- that is, incorporating knowledge and coping with globalization. Thank you very much for your kind attention. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Ehime February 5, 2020 WAKATABE Masazumi Deputy Governor of the Bank of Japan Chart 1 I. Financial and Economic Developments Global Growth Rate y/y % chg. 6.0 5.5 5.0 2021: +3.4% 4.5 2020: +3.3% 4.0 3.5 3.0 2.5 2.0 2019: +2.9% Average from 1980 through 2018: +3.5% 1.5 1.0 0.5 0.0 -0.5 CY 00 Note: Figures for 2020 and 2021 are the IMF's projections as of January 2020. Source: IMF. Chart 2 I. Financial and Economic Developments Global Decoupling between the Manufacturing and Nonmanufacturing Sectors Nonmanufacturing Sector Manufacturing Sector Heightening uncertainties (U.S.-China trade friction) ・Postponement of business fixed investment ・Decline in trade volume Adjustments in the cycle for IT-related goods Strengthened macroeconomic measures Rapid deceleration Progress in U.S.-China trade talks and Brexit Accommodative financial conditions "Decoupling" Steady consumer sentiment Tight labor market conditions Steady developments Pick-up in the IT-related sector Pick-up in the global economy Pick-up in the manufacturing sector Chart 3 I. Financial and Economic Developments Developments in the Global Manufacturing Sector s.a., DI Global Business Sentiment in the Manufacturing Sector World Semiconductor Shipments s.a., q/q % chg. -5 CY12 Notes: 1. In the left chart, figures are for the "J.P. Morgan Global Manufacturing PMI." Notes: 2. In the right chart, figures are based on BOJ staff estimates using WSTS data. Source: IHS Markit (© and database right IHS Markit Ltd 2020. All rights reserved.). -10 CY 12 Chart 4 I. Financial and Economic Developments Business Fixed Investment Real Business Fixed Investment Firms' Use of Information Technology Average Age of Fixed Capital Stock s.a., ann., tril. yen years Buildings and structures excluding dwellings Big data Tangible fixed assets AI IoT Cloud computing RPA CY 94 CY80 84 88 92 96 00 04 08 12 16 20 40 60 80 100 % Productivity enhancement Creation of new business Data analysis Sales enhancement Others Notes: 1. For details relevant to the middle chart, see BOX 3 in the January 2020 Outlook Report. 2. In the right chart, figures are from the survey for fiscal 2018. For details, see BOX 3 in the January 2020 Outlook Report. Sources: Cabinet Office; Research Institute of Economy, Trade and Industry; Ministry of Internal Affairs and Communications; Japan Users Association of Information Systems. Chart 5 I. Financial and Economic Developments Private Consumption Long-Term Developments (Quarterly) Recent Developments (Monthly) s.a., CY 2011=100 CY 09 s.a., CY 2011=100 Consumption tax hike Jan. 18 Jul. Jan. 19 Note: Figures are for the Consumption Activity Index (travel balance adjusted, real). They exclude inbound tourism consumption and include outbound tourism consumption. Sources: Bank of Japan, etc. Jul. Chart 6 I. Financial and Economic Developments Government Spending Simulation Public Investment s.a., ann., tril. yen <Case: Public Investment Increases by 1% of Nominal GDP during the First Year> s.a., ann., tril. yen Public construction completed (nominal, left scale) Public investment (real, right scale) 1.5 real GDP, deviation from baseline, % Interest rate: fixed Interest rate: not fixed (upward pressure on the rate) 1.0 CY 09 10 11 12 13 14 15 16 17 18 19 0.5 0.0 -0.5 0 year Note: For details relevant to the right chart, see BOX 1 in the January 2020 Outlook Report. Sources: Cabinet Office; Ministry of Land, Infrastructure, Transport and Tourism; Bank of Japan, etc. Chart 7 I. Financial and Economic Developments BOJ's Economic Forecasts Real GDP <January 2020 Outlook Report> 560 s.a., ann., tril. yen Fiscal 2021 +1.1% Fiscal 2020 +0.9% Fiscal 2019 +0.8% FY 12 Note: Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Cabinet Office; Bank of Japan. Chart 8 I. Financial and Economic Developments Uncertainties regarding Overseas Economies World Trade Volume and Global Machinery Investment Policy Uncertainty Index CY 1997-2015 average=100 Global economic policy uncertainty index y/y % chg. World trade volume -1 Global machinery investment CY 15 -2 CY 15 Note: In the right chart, figures for world trade volume are for real imports. Sources: Economic Policy Uncertainty; CPB Netherlands Bureau for Economic Policy Analysis; IMF. Chart 9 I. Financial and Economic Developments Developments in Private Consumption before and after the Consumption Tax Hikes Durable Goods Nondurable Goods (Automobiles + Household Electrical Appliances) s.a., average 16-18 months before the tax hike=100 s.a., average 16-18 months before the tax hike=100 Developments around the time of the October 2019 tax hike Developments around the time of the April 2014 tax hike Developments around the time of the October 2019 tax hike Developments around the time of the April 2014 tax hike -18months -12 -6 +6 +12 +18 -18 months-12 Notes: 1. Month 0 is the month in which the consumption tax rate was raised -- namely, April 2014 or October 2019. 2. In the right chart, nondurable goods include goods classified as "semi-durable goods" in the SNA. Sources: Bank of Japan, etc. -6 +6 +12 +18 Chart 10 I. Financial and Economic Developments Developments in Consumer Sentiment before and after the Consumption Tax Hikes Overall Livelihood (Consumer Confidence Index) Consumer Confidence Index s.a. Developments around the time of the October 2019 tax hike Developments around the time of the April 2014 tax hike s.a. Developments around the time of the October 2019 tax hike Developments around the time of the April 2014 tax hike Expected to improve Expected to improve Expected to worsen Expected to worsen -18 months -12 -6 +6 +12 +18 -18 months-12 -6 +6 +12 +18 Notes: 1. Month 0 is the month in which the consumption tax rate was raised -- namely, April 2014 or October 2019. 2. There is a discontinuity in the data in April 2013 due to a change in the survey method. Source: Cabinet Office. Chart 11 II. Price Developments Consumer Prices Long-Term Developments y/y % chg. Recent Developments y/y % chg. Effects of the consumption tax hikes and free education policies Energy CPI (less fresh food) -1 -2 -1 Others CPI (less fresh food) -3 CY 95 -2 CY 1 4 Note: In the left chart, figures exclude the effects of the consumption tax hikes. They incorporate the effects of the October 2019 tax hike and policies concerning the provision of free education. Source: Ministry of Internal Affairs and Communications. Chart 12 II. Price Developments BOJ's Price Forecasts CPI (All Items Less Fresh Food) <January 2020 Outlook Report> 2.5 y/y % chg. Price Stability Target (2%) 2.0 1.5 Fiscal 2019 +0.6% 1.0 Fiscal 2021 +1.4% 0.5 Fiscal 2020 +1.0% 0.0 -0.5 -1.0 FY 12 Note: Figures exclude the effects of the consumption tax hike in April 2014. Forecasts are the medians of the Policy Board members' forecasts (point estimates). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 13 III. Japanification and Economic Growth International Comparison of GDP Nominal GDP CY 1991=100 Japan U.K. Germany Nominal GDP per working-age person Nominal GDP per capita U.S. France CY 1991=100 CY 91 CY 91 Real GDP CY 91 CY 1991=100 Source: World Bank. CY 91 Real GDP per working-age person Real GDP per capita CY 1991=100 CY 91 CY 1991=100 CY 1991=100 CY 91 Chart 14 III. Japanification and Economic Growth Okun's Law Relationship between Economic Growth Rate and Unemployment Rate real GDP (y/y % chg.) FY 1956-1995 FY 1956-2018 -2 FY 1956-1995 FY 1996-2018 -4 FY 1996-2018 -6 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 unemployment rate (y/y chg., % points) Sources: Cabinet Office; Ministry of Internal Affairs and Communications. Chart 15 III. Japanification and Economic Growth Total Population and Gross Domestic Product of Ehime Prefecture 1.60 mil. persons tril. yen 5.6 5.4 1.55 5.2 1.50 5.0 1.45 4.8 1.40 4.6 1.35 Population (left scale) 4.4 Nominal gross prefectural domestic product (right scale) 1.30 4.2 Real gross prefectural domestic product (right scale) 1.25 FY 00 Source: Cabinet Office. 4.0 Chart 16 III. Japanification and Economic Growth Relationships between Population Growth and GDP/Inflation Population Growth and Inflation Population Growth and GDP Growth per Capita real GDP per capita (average 1961-2018, y/y % chg.) CPI (average 1961-2018, y/y % chg.) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 0.0 0.5 1.0 1.5 2.0 population (average 1961-2018, y/y % chg.) population (average 1961-2018, y/y % chg.) Notes: 1. Figures are those of 22 OECD member countries for which data from 1961 onward are available. 2. In the right chart, figures for Israel, Mexico, and Turkey, of which inflation rates are above 10 percent, are not shown. Source: World Bank. Chart 17 III. Japanification and Economic Growth Potential Growth Rate Recent Developments y/y % chg. Developments in the 1960s-80s average y/y % chg. Labor Number of employed persons Hours worked Capital stock Total factor productivity Real GDP growth rate Capital stock Total factor productivity Potential growth rate -1 -2 FY 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 Note: In the right chart, figures are from the "White Paper on International Economy and Trade 1998." Sources: Ministry of International Trade and Industry; Bank of Japan. 60s 70s 80s Chart 18 III. Japanification and Economic Growth Evidence of Slowdown in Physical Aging Average Number of Teeth Average Walking Speed meters/second 1.45 5 years younger! number of teeth 1.42 10 years younger! 1.40 1.38 1.37 CY 2007 CY 2017 CY 2005 CY 2016 1.35 1.33 1.30 1.30 1.25 1.21 1.20 1.15 1.10 Age 65-69 70-74 Age 65-69 75-79 70-74 75-79 Notes: 1. See Toshitaka Sekine, "Does Demography Really Matter?," presentation at the G20 Symposium titled "For a Better Future: Demographic Changes and Macroeconomic Challenges," 2019. Notes: 2. In the left chart, average walking speed is the arithmetic average of men's and women's walking speeds. Sources: National Center for Geriatrics and Gerontology; Ministry of Health, Labour and Welfare. Chart 19 Conclusion Price Developments in G7 Countries 3.0 y/y % chg. Average from 2000 through 2012 Average from 2013 through 2019 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 Japan U.S. Germany U.K. France Italy Canada Notes: 1. Figures for Japan are the CPI (excluding the effects of the April 2014 consumption tax hike and incorporating the effects of the October 2019 tax hike and policies concerning the provision of free education); those for U.K. and Canada are the CPI; those for U.S. are the PCE deflator; and those for the euro area countries are the HICP. 2. The figure for the U.S. for 2019 is the January-November average. Sources: Ministry of Internal Affairs and Communications; Haver.
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Speech by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nara, 6 February 2020.
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February 6, 2020 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Nara MASAI Takako Member of the Policy Board (English translation based on the Japanese original) I. Developments in Economic Activity and Prices I would like to start my speech with a look at developments in economic activity and prices. Following the discussion at the Monetary Policy Meeting (MPM) held in January 2020, the Bank of Japan published the Outlook for Economic Activity and Prices, or the Outlook Report. In this report, the Bank presented its projections for Japan's economic activity and prices from fiscal 2019 through fiscal 2021. I will explain developments in economic activity and prices by presenting the main content of the Outlook Report. A. Overseas Economies Let me first touch on the current situation for overseas economies. The Bank assesses that they have been growing moderately on the whole, although slowdowns have continued to be observed. Downside risks concerning overseas economies seem to be still significant. However, I feel that they have eased somewhat recently, mainly reflecting progress in the U.S.-China trade negotiations and in the United Kingdom's exit from the European Union. This view seems to be shared among, for example, international organizations, as evidenced by the World Economic Outlook (WEO) Update released in January 2020 by the International Monetary Fund (IMF), in which the IMF assessed that the balance of risks to the global outlook remained on the downside but was less skewed toward adverse outcomes than in October.1 In terms of the outlook for overseas economies, although it will take some time for the growth pace to pick up, they are expected to grow moderately on the whole, with the growth rates rising on the back of the materialization of the effects of macroeconomic policies in each country as well as a pick-up in the manufacturing sector, due mainly to the global cycle for IT-related goods shifting toward a phase of improvement. According to the January 2020 WEO Update, the growth rate of the global economy is projected to pick up See https://www.imf.org/en/Publications/WEO/Issues/2020/01/20/weo-update-january2020. gradually to around 3.4 percent -- about the same level as the past average -- in 2021, led by emerging economies, amid continued accommodative financial conditions. In fact, there seem to be signs of recovery in the manufacturing sector. For example, the Global Purchasing Managers' Index (PMI) for manufacturing, which is highly correlated with world trade volume, showed signs of a pick-up, exceeding the 50 mark for the first time in seven months in November 2019; by region, the Manufacturing PMIs for the NIEs and ASEAN economies, excluding Hong Kong, also exceeded the 50 mark in December, due to the cycle for IT-related goods shifting toward a phase of improvement. I have been paying particular attention to the timing and the pace of a pick-up in overseas economies, especially in manufacturing, and my assessment is that, if these developments continue, overseas economies will pick up through the first half of 2020. B. Japan's Economy 1. Current situation The Bank assesses that Japan's economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports, production, and business sentiment have shown some weakness, mainly affected by the slowdown in overseas economies and natural disasters. Looking at the December 2019 Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion index for business conditions for all industries and enterprises (the proportion of firms responding that business conditions were "favorable" minus the proportion of those responding that they were "unfavorable") remained in positive territory, as that for nonmanufacturing stayed at a favorable level reflecting an increasing trend in domestic demand, while that for manufacturing indicated a clear increase in cautiousness. The real GDP growth rate for the July-September quarter of 2019 was 1.8 percent on an annualized quarter-on-quarter basis, registering a positive figure for the fourth consecutive quarter, underpinned by domestic demand such as business fixed investment and government spending. The characteristics of the current situation -- where domestic demand underpins weak external demand, which is contrary to export-led economic expansion phases in the past -- have been maintained. Let me elaborate on this by looking at developments by demand component. With regard to external demand, exports, mainly of automobile-related goods and capital goods, have continued to show some weakness with the continued slowdown in overseas economies. Industrial production has decreased, partly due to the effects of natural disasters -- such as the 2019 Typhoon No. 19 -- on supply chains. On the other hand, as for domestic demand, business fixed investment has continued on an increasing trend, with corporate profits staying at high levels on the whole. Looking at this in detail, many construction investment projects appear to aim at rejuvenating vintage building stock, such as replacement of aging existing buildings. In addition, software investment related to big data, artificial intelligence (AI), and the Internet of Things (IoT), as well as research and development (R&D) investment related to CASE, have continued to increase steadily.2 Public investment also has been expanding moderately, especially for construction related to restoration and reconstruction following natural disasters as well as to national resilience. Private consumption has been increasing moderately, albeit with fluctuations due to such effects as of the October 2019 consumption tax hike, against the background of steady improvement in the employment and income situation. Meanwhile, supply-demand conditions in the labor market have remained tight, as evidenced by the unemployment rate remaining at around the lowest level observed in the current economic expansion phase, being in the range of 2.0-2.5 percent. 2. Outlook Japan's economy is likely to continue on an expanding trend throughout the projection period -- that is, through fiscal 2021 -- as the impact of the slowdown in overseas economies on domestic demand is expected to be limited, although the effects of the slowdown are likely to remain for the time being. Although exports likely will show some weakness for the time being in a situation where a pick-up in overseas economies is expected to take some time, they are projected to return to a moderate increasing trend with the pick-up in overseas economies. Some indicators have "CASE" is a term that stands for Connected, Autonomous, Shared & Services, and Electric. started to show positive signs regarding external demand. For example, exports of IT-related goods, especially for smartphones and data centers, have turned to an increasing trend recently, and likely will maintain the firm increasing trend, partly underpinned by demand related to the introduction of 5G communication technology. Information obtained from interviews with firms in the January 2020 Regional Economic Report includes a view that a full-fledged recovery in exports of semiconductor manufacturing equipment to China could be expected with the improvement in the global cycle for IT-related goods. 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, mainly against the background of highly accommodative financial conditions and active government spending. Business fixed investment -- mainly construction investment related to urban redevelopment projects and that aimed at meeting inbound tourism demand, investment aimed at improving efficiency and saving labor to address labor shortage, as well as software investment and R&D investment for growth areas -- is likely to continue increasing moderately amid accommodative financial conditions, although it is expected to decelerate temporarily, mainly in machinery investment by manufacturers, due to the effects of the slowdown in overseas economies, and such factors as an accumulation of capital stock are projected to exert downward pressure from a somewhat longer-term perspective. Private consumption is expected to follow a moderate increasing trend with such effects as of the consumption tax hike waning gradually. Meanwhile, government spending is likely to increase steadily through fiscal 2020, mainly due to (1) expenditure such as for disaster-related restoration and reconstruction as well as national resilience, both of which reflect the Comprehensive Economic Measures to Create a Future with Security and Growth decided by the Cabinet in December 2019, and to (2) Olympic Games-related demand. Thereafter, it is expected to remain at a relatively high level and underpin economic activity. Reflecting these developments in demand at home and abroad, Japan's real GDP may temporarily decline in the second half of fiscal 2019 from the first half, due mainly to the effects of the slowdown in overseas economies, the consumption tax hike, and natural disasters, but thereafter likely will see a gradual acceleration in its growth pace through fiscal 2021. In terms of the medians of the Policy Board members' forecasts in the January 2020 Outlook Report, the real GDP growth rate is 0.8 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.1 percent for fiscal 2021. 3. Risks to the outlook I consider it important that domestic and external demand grow in a well-balanced manner in order to achieve sustainable economic growth. From this viewpoint, among the risks to the Bank's baseline scenario regarding the outlook for the economy, I would like to point out two to which I currently pay particular attention. First, as for external demand, developments in overseas economies remain a risk factor. Although downside risks concerning overseas economies have decreased somewhat, mainly reflecting the progress in the U.S.-China trade negotiations, they are still significant. In particular, I think that it is necessary to pay close attention to the effects on the world economy -- including the Chinese economy -- caused by the spread of the novel coronavirus, and the impact of these downside risks on firms' and households' sentiment in Japan. Second, turning to domestic demand, I consider that the key question is whether the moderate increasing trend in private consumption will be maintained. The effects of the consumption tax hike in October 2019 seem likely to be restrained compared with at the time of the previous tax hike in 2014, partly due to various measures implemented by the government to support households -- for example, a point reward program when using cashless payments, an increase in welfare benefits for pensioners, and the issuance of goods vouchers issued with a premium. However, I would like to closely monitor whether there will be a change in the trend in private consumption in the long run, as the effects of the decline in real income may appear gradually over time. C. Price Developments 1. Current situation Next, I will turn to price developments in Japan. Regarding recent price developments, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food has been at a level around 0.5 percent, including the effects of the consumption tax hike and policies concerning the provision of free education since October 2019, mainly because of downward pressure on prices caused by the past decline in crude oil prices and reductions in mobile-phone-related prices. There has been no change in the Bank's assessment that prices have continued to show relatively weak developments compared to the economic expansion and tight labor market conditions. The background to why it has been taking time for prices to rise is explained in detail in the July 2018 Outlook Report.3 To explain this once again, it has been pointed out that the factors specific to Japan -- namely, the situation where the mindset and behavior based on the assumption that wages and prices will not increase easily have been deeply entrenched, due mainly to the experience of prolonged low growth and deflation -- in addition to global ones such as technological progress brought about by digitalization, have been affecting prices. It has been taking time to resolve these factors specific to Japan that have been delaying price rises, and the situation likely has continued in which the responsiveness of prices to the output gap, as well as inflation expectations that are strongly affected by the adaptive formation mechanism, do not rise easily. Nevertheless, I hold the view that the inflation momentum has been maintained and factors that could trigger an increase in it continue to be detected.4 For example, housing rent is gradually turning to an increase in the CPI. The July 2018 Outlook Report that I mentioned earlier pointed out -- based on a comparison among Japan, the United States, and Germany in terms of the year-on-year rate of change in the CPI excluding food and energy for fiscal 2017 -- that the low rates of increase in administered prices and housing rent contributed significantly to the low inflation rate in Japan, which was the lowest among the three countries. 5 The January 2020 Outlook Report pointed to the continued lackluster See https://www.boj.or.jp/en/mopo/outlook/gor1807a.pdf. See Masai Takako, "Economic Activity, Prices, and Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Mie," Bank of Japan, September 2019. 5 See Box 6 "Developments in Administered Prices and Housing Rent," in the July 2018 Outlook Report. When imputed rent is included, the total share of housing rent and administered prices accounts for almost 50 percent of the CPI excluding food and energy. developments in administered prices and housing rent as a factor delaying price rises. In this respect, housing rent has continued to make positive contributions to the CPI for Tokyo's 23 wards as a trend since around the middle of 2018 against the backdrop of the recent uptrend in land prices. On a nationwide basis, the contributions turned positive for the first time in 11 years in the CPI for November 2019. If this trend continues, housing rent will be a factor affecting the long-term trend in prices, and I am paying attention to this situation. Turning to overseas economies, there have been active discussions regarding factors causing low inflation and policy conduct in such an environment, reflecting the continuing global phenomenon of prices not rising easily. In this situation, prices in Japan have shown somewhat different developments recently compared with those in other countries. Looking at the long-term price trends, the inflation rate has risen in Japan while it has declined in the United States and Europe. In my view, the background to the situation where the inflation rate in Japan has been rising in general, despite the global trend of prices not rising easily, reflects in substantial part the powerful monetary easing that the Bank has been pursuing based on the joint statement with the government in January 2013. 2. Baseline scenario of the outlook for prices With regard to the outlook for prices, the year-on-year rate of change in the CPI for all items less fresh food is likely to increase gradually toward 2 percent, mainly on the back of the output gap remaining positive and medium- to long-term inflation expectations rising. The medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI for all items less fresh food presented in the January 2020 Outlook Report was 0.6 percent for fiscal 2019, 1.0 percent for fiscal 2020, and 1.4 percent for fiscal 2021. 3. Risks to prices I now would like to talk about two points that I consider risks to the baseline scenario of the outlook for prices. The first point is future developments in real wage growth. From a long-term perspective, wages and prices generally have moved in tandem with each other. In fact, households' tolerance toward price rises has started to increase, albeit at a moderate pace, on the back of the improvement in the employment and income situation. I consider it necessary that these positive developments further gain momentum on the back of a greater increase in real wages in order to maintain the Bank's baseline scenario. The second point is developments in foreign exchange rates and international commodity prices. I still consider these to be risks since they not only directly affect prices but also may adversely affect business and household sentiment. II. The Bank's Monetary Policy Next, I will talk about the Bank's monetary policy. A. Current Monetary Policy Framework The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI and is conducting the current framework of Quantitative and Qualitative Monetary Easing with Yield Curve Control to achieve this target at the earliest possible time. Specifically, it sets the short-term policy interest rate at minus 0.1 percent and the target level of 10-year Japanese government bond (JGB) yields at around 0 percent in the guideline for market operations, and has been taking measures such as JGB purchases to achieve the target levels. The Bank has thus supported the economic activity of firms and households by maintaining highly accommodative financial conditions. Regarding the conduct of monetary policy, the Bank has demonstrated its stance to decide on monetary policy that is considered most appropriate, taking account of developments in economic activity and prices as well as financial conditions at the time in a comprehensive manner. In particular, since summer 2019, in a situation where downside risks to economic activity and prices, mainly regarding developments in overseas economies, have been heightening, the Bank has further clarified its intention by clearly demonstrating the policy stance of being tilted toward monetary accommodation, and has conducted monetary policy that puts a focus on strengthening its external communication. Specifically, the public statement released after the July 2019 MPM put forth that the Bank would not hesitate to take additional easing measures if there was a greater possibility that the inflation momentum would be lost. In October, the Bank decided on a new forward guidance for the policy rates with a view to clarifying its policy stance of being further tilted toward monetary accommodation. Namely, it stated that, as for the policy rates, it expected shortand long-term interest rates to remain at their present or lower levels as long as it was necessary to pay close attention to the possibility that the momentum toward achieving the price stability target would be lost. B. Future Conduct of Monetary Policy At the January 2020 MPM, it was reaffirmed that the momentum toward achieving the price stability target of 2 percent was maintained but not yet sufficiently firm, and thus developments in prices continued to warrant careful attention. Specifically, downside risks to Japan's economic activity and prices stemming from overseas economies seem to be still significant, although they have decreased somewhat. As for the future conduct of monetary policy, my view is that the Bank should not hesitate to take additional easing measures if there is a greater possibility that the momentum will be lost due to materialization of these risks. Nevertheless, accommodative financial conditions have been prolonged around the globe amid a sluggish rise in growth expectations. It therefore is natural that concerns over the risk-taking stance, mainly among firms and investors, strengthening further reflecting the continued low interest rate environment, have been recognized among, for example, international organizations.6 I also am aware of these concerns including a negative impact on economic activity of a decline in such rates of return as on pension products. Nonetheless, in my view, it is still indispensable that Japan persistently continues with the current policy so as to overcome deflation completely and drive sustainable economic growth. The Bank will persistently devise measures considered necessary at the time and continue to conduct monetary policy in an appropriate manner while carefully paying attention to both the positive effects and side effects of its policy. For example, see the Global Financial Stability Report released by the IMF in October 2019. III. Promotion of Women's Participation in the Economy At a meeting with business leaders in Ehime in August 2017, I remarked that promotion of women's participation in Japan's economy was essential in terms of increasing its growth potential amid the ongoing decline in the working-age population and the worsening of labor shortages, and that one option for firms was to aim at starting a business revolution by using women's participation and advancement in the workplace as a driving force. I once again will touch upon the promotion of women's participation in the economy. At the Group of 20 (G20) Osaka Summit in June 2019, the Leaders' Special Event on Women's Empowerment was held. At the event, it was confirmed that further efforts would be made in three priority areas -- namely, increasing women's labor participation, enhancing support for girls' and women's education, including science, technology, engineering, and mathematics (STEM) education, and engaging with women business leaders and entrepreneurs.7 Also, at the annual meeting of the American Economic Association in January 2020 -- where Dr. Janet L. Yellen, former chair of the Board of Governors of the Federal Reserve System, serves as president -- sessions on topics such as gender were held in a situation where voices were heard regarding a lack of diversity in the economics profession where the number of white men was disproportionately high. One of them was titled "Women in Central Banking," a panel session in which women central bankers in senior positions from the United States and Europe participated.8 Turning to the situation in Japan, amid this global trend, it has been taking initiatives in 12 areas, such as increasing the employment rate for women and fostering women leaders, to achieve the numerical goals by 2020 under the leadership of the Gender Equality Bureau of the Cabinet Office in accordance with the Fourth Basic Plan for Gender Equality formulated in December 2015. Achievement of the goals has come within reach with respect to some of those initiatives. For example, the latest figure for the employment rate for women between the ages of 25 to 44 years was 76.5 percent in 2018, whereas the goal is to raise the rate to See https://www.mofa.go.jp/policy/economy/g20_summit/osaka19/pdf/special_event/en/special_ event_03.pdf. 8 See https://www.aeaweb.org/conference/2020/preliminary/2263?q=eNqrVipOLS7OzM8LqSxIV bKqhnGVrJQMlWp1lBKLi_OTgRwlHaWS1KJcXAgrJbESKpSZmwphlWWmloO0FxUUXDAFT A1AegsS01Mh5lwwXDBunx4U. 77 percent by 2020. On the other hand, it is true that there is still a gap between the ideal vision and reality with respect to some other initiatives. Specifically, the latest figure for the proportion of women board members at listed companies was 5.2 percent in 2019, while the goal is to raise the proportion to 10 percent by 2020. This may have been reflected in the latest rankings of countries in terms of the Global Gender Gap Index released by the World Economic Forum in December 2019, in which Japan ranked 121st out of the total of 153 countries -- the lowest ranking ever for Japan, down from 110th place in 2018. Still, I feel that changes in people's perception, which is a basis for women's participation in the economy, are taking place steadily. For example, according to a survey conducted by the Cabinet Office on the proportion of people who believed that "it is better to raise boys to be masculine men and girls to be feminine women," the proportion of those who upheld that belief was 74.8 percent among women (mothers) and 78.3 percent among men (fathers) in 1972; in 2014, the figures declined to 40.4 percent and 64.1 percent, respectively. While the survey results show that women's perception regarding gender stereotypes has changed relatively significantly, they also reveal a new challenge in that the change in men's perception is relatively small, causing a perception gap between fathers and mothers. I believe that, by conscientiously dealing with each of these kinds of challenges, the empowerment of women will bring about a positive change in norms. "Problems that currently seem impossible to solve will not necessarily remain unsolved. Sometimes, such problems can be solved through strenuous efforts, although it may take time. The important thing is to open the path toward solving problems by thoroughly providing information on successful cases." This was an observation made in an interview with Ms. Ogata Sadako, who dedicated herself to resolving refugee problems for many years as both the first woman and first Japanese person to serve as the United Nations High Commissioner for Refugees (UNHCR), and who passed away in October 2019. 9 These words by Ms. Ogata, who was on the front line as a woman leader, appear to hold regarding the empowerment of women as well. See https://www.japanforunhcr.org/archives/3833/ (available in Japanese only).
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Keynote speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at a seminar hosted by the Tokyo Stock Exchange, Tokyo, 14 February 2020.
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February 14, 2020 Bank of Japan Financial Literacy: Money Management for Creating a Life of Well-Being Keynote Speech at a Seminar Hosted by the Tokyo Stock Exchange AMAMIYA Masayoshi Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is an honor to have this opportunity today to address such a large audience. Today, I would like to talk about financial literacy. Financial literacy refers to the knowledge and decision-making skills used to manage one's money and personal finances. I have chosen this topic because of its relevance to the advent of an unprecedented aging society, which has been called the era of the 100-year life. In order to live a long life in your own way and, more importantly, at a high level of well-being, it will be more important than ever to have the knowledge and decision-making skills necessary to deal wisely with money. Financial literacy has drawn international attention as one of the lessons learnt from the global financial crisis more than a decade ago. The idea is that, to secure financial stability, it is essential not only to strengthen financial regulations and supervision, but also to improve the financial literacy of individual people, who act as investors. Indeed, at the G20 Los Cabos Summit in 2012, the Leaders Declaration emphasized the importance for each country to work strategically and systematically to provide financial education to people at all stages of life. Also, at the G20 Finance Ministers and Central Bank Governors Meeting chaired by Japan last year, the strengthening of financial literacy was put forward as a policy priority.1 Meanwhile, in Japan, the aging of the population, the increased use of cashless payment, and the money and asset management associated with them have become increasingly popular topics in the media. These topics have raised alarming cases highlighting the necessity for financial literacy education. First, regarding population aging, if we make erroneous decisions on money, the increasing longevity that should be celebrated, could instead become a cause for increased financial burden. Second, the increasing use of cashless payment, which has improved convenience in our daily lives, requires us to be even more careful about overspending or the misuse of personal information. And third, as the legal age of adulthood in Japan will be lowered in April 2022, young adults will be required to make decisions and assume responsibility as independent contracting parties from the age of 18, when most of them are still in high school. The Global Partnership for Financial Inclusion and the Organisation for Economic Co-operation and Development (OECD), "G20 Fukuoka Policy Priorities on Aging and Financial Inclusion," June 2019. In this way, financial literacy is expected to become even more important. So, what is the current state of financial literacy among the population of Japan? The Central Council for Financial Services Information, which has its secretariat in the Public Relations Department of the Bank of Japan, conducted a survey on this point. Today, I will explain the current state of financial literacy in Japan and the challenges it raises, while making international comparisons based on the survey. I. The Central Council for Financial Services Information First, I would like to provide an introduction to the Central Council for Financial Services Information. As I just mentioned, the Council has its secretariat in the Public Relations Department of the Bank of Japan. It promotes the advancement of financial knowledge under the following two principles: to provide financial and economic information, and to disseminate pecuniary education. It has a nationwide network with local committees in all 47 prefectures in Japan. In coordination with the head office, branches, and local offices of the Bank of Japan, as well as the government, local public bodies, private entities, and others, the Council works to enhance financial literacy in Japan from a neutral and fair position. Before I continue, I would like to add that Mr. SHIBUSAWA Ken, who will be speaking after me, and with whom I will be holding a discussion session later, has a relationship with the Central Council. Mr. SHIBUSAWA's great uncle -- his grandfather's older brother -- was Viscount SHIBUSAWA Keizo, the 16th Governor of the Bank of Japan. Viscount SHIBUSAWA successively assumed the posts of Governor of the Bank of Japan and Minister of Finance, and from 1952, he served as the first chairman of the Central Council, which was then called the Central Council for Savings Promotion. Moreover, Viscount SHIBUSAWA inherited the title from his grandfather, SHIBUSAWA Eiichi, who is well known for the founding of many banks and firms, including Dai-ichi Kokuritsu Ginko (the First National Bank), and who helped lay the foundations for modern Japan in the Meiji and Taisho periods from the late 19th century to the early 20th century. SHIBUSAWA Eiichi has been very much in the news recently as his life is the subject of the NHK Taiga Drama (the annual year-long historical drama television series produced by NHK [Japan Broadcasting Corporation]) to be aired in 2021. SHIBUSAWA Eiichi also has a close relationship with the Bank of Japan, and his portrait will be printed on the new 10,000 yen Bank of Japan note to be issued from 2024. II. Results of the Financial Literacy Survey A. Overview Now, I would like to move on to the main topic. The Central Council for Financial Services Information conducted the Financial Literacy Survey last year. This survey was conducted for the first time in 2016 and for the second time last year with the aim of understanding the current state of financial literacy in Japan. It is an online questionnaire targeting 25,000 individuals aged 18 to 79 sampled throughout Japan. The questions in the survey can be largely divided into two types (Chart 1). The first type of questions are true/false questions on "financial knowledge and financial decision-making skills." These are questions with correct answers, such as, "If interest rates rise, what will typically happen to bond prices?" The correct answer is, "They will fall." The other type of questions are those on "characteristics of behavior and attitude." These questions ask the respondents how much each of the given statements, such as, "I set long-term financial goals and strive to achieve them," apply to them personally. These questions have no correct answer, and ask the respondents about their current state or attitude. Next, I will introduce some interesting points and implications from the results of the 2019 survey. B. Survey Results 1. Percentage of correct answers given to true/false questions Looking at the percentage of correct answers given to the 25 true/false questions, the nationwide average was 56.6 percent, an increase of 1 percentage point on the previous 2016 survey (Chart 2). The percentage of correct answers rose in all categories of the Financial Literacy Map, including family budget management and financial knowledge. Also, the percentages increased in almost all regions. In other words, financial literacy in Japan has risen moderately overall over the past three years. By age group, the percentage of correct answers tended to be higher for older age groups. This confirms that people's financial literacy increases with various experiences through life and with more opportunity to engage in financial transactions and acquire financial and economic information. How does the level of financial literacy in Japan compare with that in other countries? When comparing the percentage of correct answers given to the 11 common questions asked in the Financial Literacy Survey with the results of a survey compiled by the International Network on Financial Education (INFE) of the Organisation for Economic Co-operation and Development (OECD), Japan ranked low, at 22nd out of 30 (Chart 3). As the results could be affected by such factors as how the surveys were conducted and the nuance of the questions, some leeway should be allowed. Nonetheless, financial literacy in Japan still has much room for improvement, particularly in comparison with other countries and economies. Looking at the results in more detail to find why Japan ranks so low, the percentage of correct answers was notably low for questions on three subjects: inflation, compound interest, and diversified investment. I will explain each of these specifically. First, as for inflation, the true/false question was on the statement, "High inflation means that the overall cost of living is increasing rapidly." The correct answer is of course "True." The percentage of respondents who gave the correct answer in Japan was 62 percent, which was far below that in other countries and economies, such as 97 percent in Hong Kong (China) and 92 percent in Canada. Nevertheless, Japan's percentage soared for older age groups, and nearly 80 percent of the respondents aged 60 or older answered correctly. I assume that this age group remembers experiencing high inflation at times such as oil crises in the past, and this led to a higher number of them giving the correct answer. Next, regarding compound interest, the question asked how much would be in a savings account after five years if 1 million yen is put into the account with a guaranteed interest rate of 2 percent per year, and no further deposits or withdrawals are made, and tax deductions are disregarded. The five options were: "More than 1.1 million yen"; "Exactly 1.1 million yen"; "Less than 1.1 million yen"; "Impossible to tell from the information given"; and "Don't know." The correct answer is "More than 1.1 million yen," due to compound interest. Less than half of respondents in Japan chose the correct answer -- 44 percent to be precise, whereas 75 percent in the United States and 65 percent in Norway answered correctly. Speaking of compound interest, Albert Einstein is said to have stated that compound interest is man's greatest invention.2 What he actually intended by this remark is not known, but some say that, having witnessed the rapid growth of the capitalist economy, Einstein regarded compound interest as a symbol of the power of finance, which served as the driving force for growth. Lastly, the question on diversified investment asked whether the statement, "Buying a single company's stock usually provides a safer return than a stock mutual fund," was true. The percentage of respondents who selected the correct answer "False" was 47 percent in Japan, and about the same portion selected "Don't know." Japan's result was again notably low when compared with other countries and economies, such as 84 percent in South Korea and 80 percent in Jordan. The percentage of correct answers given to all three of these questions tended to rise for older age groups, suggesting that experience is an essential factor in acquiring financial literacy. In particular, Japan has long experienced deflation or low inflation, extremely low interest rates, and financial asset holdings centered on deposits and savings. It is therefore no surprise that the percentage of correct answers on the subjects of inflation, compound interest, and diversified investment was low, particularly among the youngest respondents, the 18-29 age group. Financial education in schools, universities and so on will therefore play an important role in compensating for their lack of experience. I would like to touch upon financial education again later on. 2. Characteristics of respondents with high scores What advantages come with having high financial literacy? Let me give an example. Chart 4 shows the relationship between the proportion of respondents who had experienced financial trouble, such as so-called special fraud and multiple debts, and the percentage of those who gave correct answers.3 Looking at these two by prefecture, we see a negative correlation. In other words, the higher the financial literacy, the less likely it is to find oneself in financial The New York Times, "EINSTEIN REVISITED," May 27, 1983. Special fraud refers to a type of fraud or extortion offense in which the offender deceives their victim, over the phone or by other means, such as into transferring money to a designated account. trouble. I find it extremely regrettable to say that damage caused by financial crime in Japan remains at a high level. According to a report by the National Police Agency, the number of recorded cases of special fraud, including telephone-based identity deception, was about 16,000 cases in 2018, resulting in as much as 36 billion yen worth of damage.4 Simple math reveals that one such case of fraud occurs every 30 minutes on average in Japan, causing 100 million yen worth of damage per day. Someone, somewhere in Japan, could well become a victim of special fraud even as I deliver this 30-minute speech. I should also note that these figures only represent those cases and the amount of damage recorded by the police, so the true figure is likely to be even higher. In Japan, people continue to fall victim not only to special fraud but to various other forms of financial crime. I believe that improving financial literacy is an effective means of defense by which to reduce the number of such victims. Apart from this, respondents with high scores in this survey share certain behavioral characteristics. For example, (1) they keep up-to-date with the latest financial and economic information, (2) they securely manage their family budget, (3) they have a long-term financial plan, (4) they have emergency or rainy day funds set aside, and (5) they purchase a financial product only after comparing it with other products and understanding the product details. As these patterns show, those with high financial literacy have sufficient knowledge and understanding of money and related issues, which in turn gives them high resilience to any economic shocks or financial troubles. C. Other Topics Turning to the bigger picture, I would now like to introduce two points regarding the characteristics of Japanese people's financial behavior and attitude, according to the Financial Literacy Survey. 1. Investment stance The first point concerns investment stance (Chart 5). Let us look at the answers given to the following question: "Suppose that, if you invested 100,000 yen, you would either get a capital gain of 20,000 yen or a capital loss of 10,000 yen at a 50 percent probability. What would National Police Agency, Cases of Special Fraud Reported and Arrested, 2018 (Final Figures), available only in Japanese. you do?" This is an investment with an expected return of 5,000 yen, that is, an expected rate of return of 5 percent. The results show that more than three quarters of the respondents answered, "I would not invest," suggesting that many are risk averse against losses resulting from potential price declines. A preference for loss aversion is not necessarily unfavorable, but if such behavior reflects a lack of financial knowledge, that would be a different story. In this regard, it is cause for concern that nearly 40 percent of the total respondents answered that they acquire financial and economic information -- through newspapers, magazines, television, websites, and other sources -- less than once a month, which was unchanged from the previous survey. Meanwhile, when respondents were asked, "Have you ever invested an amount of money that exceeded your monthly living expenses?" about three quarters of them answered, "I have not invested such an amount of money." From this, we can conclude that Japanese people's investment stance is still conservative. This conservative investment stance is also evident in the results of the Survey on Household Finances, a survey conducted annually by the Central Council for Financial Services Information (available only in Japanese; Chart 6). This survey comprises two separate questionnaires: one targeting two-or-more-person households, and the other targeting singleperson households. When both types of households were asked, "To what extent do you intend to hold financial products that have a risk of falling below par, but are expected to be profitable, over the next one or two years?" about 80 percent of two-or-more-person households and about 60 percent of single-person households answered, "I have no intention of holding such products." Nevertheless, in the past few years, the proportion of respondents answering, "I intend to hold such products," has increased slightly among both groups.5 2. Funds for retirement The second point concerns funds for retirement. Going back to the Financial Literacy Survey, respondents were asked to select the expenses they thought they would have to cover in the future. The category "living expenses for retirement" was selected most, by about 60 percent of respondents. While this reflects their strong awareness about retirement, the proportion of The amount outstanding of households' financial assets in Japan is approximately 1,900 trillion yen. However, it is known that the majority of these are held in the form of cash and deposits, and that the proportion of risk assets such as stocks and investment trusts is extremely small compared with other countries (Bank of Japan, Flow of Funds, Fiscal Year 2018). those who had a detailed financial plan laid out for "living expenses for retirement" was only about 30 percent, even among those in their 50s -- for whom retirement is approaching. And this figure represents a decline from the previous 2016 survey (Chart 7). Similarly, focusing on respondents in their 50s, the percentage of those who were "aware of" the amount of public pension they were entitled to receive was slightly below 40 percent. For those who are 50 and above, the Nenkin Teiki Bin (Pension Coverage Regular Notice), a postcard sent annually from the Japan Pension Service, shows the anticipated amount of pension benefits they will receive. If you are not familiar with this notification, I strongly recommend you check this postcard. Japan has one of the most rapid rates of declining birthrate and aging population in the world. As of 2018, the average life expectancy was 81 years for men and 87 years for women, and the proportion of those aged 65 years or older reached almost 30 percent of the total population.6 While public pensions are generally the main source of income after retirement in Japan, it is important to accumulate financial assets as necessary and take measures to ensure these assets last for as long as possible, in accordance with one's life plan. In order to do this, it is necessary to acquire a good understanding of money and devise a secure financial plan for living expenses for retirement while still young. Moreover, given the survey results showing that less than half of those in their 50s have a financial plan for living expenses for retirement or know the anticipated amount of public pension benefits they will receive, we would have to say that there is still significant room for improvement in Japanese people's financial literacy, especially in this era of the 100-year life. Closing Remarks In sum, financial literacy in Japan is gradually improving, but it is not at a high level in comparison with other countries. When people's financial literacy improves, they tend to exhibit desirable financial behavior, such as setting long-term financial goals, and they become less likely to find themselves involved in financial trouble. With advances in digitization and the widespread use of smartphones, access to financial information and services has become easier and more convenient, which is why we must acquire the Ministry of Health, Labour and Welfare, "Abridged Life Tables for Japan 2018"; Ministry of Internal Affairs and Communications, "Current Population Estimates as of October 1, 2018." knowledge necessary to make the wisest and most effective use of these opportunities. So, what do we need to further improve financial literacy in Japan? I think that education holds the key. The knowledge and decision-making skills necessary for money and personal finance change over time. It is therefore important to continue learning these skills and acquiring this knowledge at school, university, and so on, and to deepen this understanding through real-world experience throughout one's lifetime. Looking at the results of the Financial Literacy Survey by attribute, the percentage of correct answers given by "those who recognized themselves as having received financial education" offered by school or workplace was frequently higher than those who did not, and they also exhibited more desirable financial behavior (Chart 8). However, the proportion of those who received financial education is still not so high (Chart 9). In recent years, owing to the efforts of the people concerned, the proportion among the youngest respondents, the 18-29 age group, who received financial education is higher than among the older generations, and has increased slightly from the time of the previous 2016 survey. Yet the reality is that it is still less than 20 percent. As I recall, it used to be considered taboo in Japan to talk about money to children, but this tendency seems to have faded considerably in recent years. I would like to emphasize that financial education is to learn about money so as to understand the workings of the world they live in and make reasonable assessments and judgments in life. The contents of financial education have been greatly expanded in the new Courses of Study that will be implemented in primary schools in fiscal 2020, and later in secondary schools and high schools. At universities as well, an increasing number of faculty want their students to have the opportunity to participate in financial education before they graduate. Also, the proportion of those who were taught how to manage their finances by their parents or guardians at home is higher among younger age groups than among older generations. As I mentioned at the outset, the momentum to improve financial literacy through financial education is increasing worldwide. Amid this trend, the Central Council for Financial Services Information has been carrying out various activities to promote financial education. The main activities are grassroot initiatives undertaken in coordination with its local committees, such as providing visiting lectures on financial literacy at educational institutions from kindergarten to university, and holding seminars for workers or teachers. The number of people who participated in lectures or seminars offered by the Council and other related organizations such as the Financial Services Agency, the Japanese Bankers Association, and the Japan Securities Dealers Association totaled around 600,000 during fiscal 2018. In addition, the Council publishes pamphlets and booklets for different age groups to meet their respective needs (Chart 10). It also publishes a quarterly public relations magazine about various topics on money, titled Kurashi-juku Kin'yu-juku ("First steps toward financial literacy for everyday life"; available only in Japanese). All of these are provided free of charge, and we would be very pleased if you could make use of them. Further information on the Central Council's activities, together with related releases, is also available on its official website, "Shiruporuto" (Gateway to Knowledge), which is a nickname of the organization. Recently, the number of page views has increased remarkably. This is particularly gratifying as it is an indication of the public's growing interest in financial literacy and financial education. Last but not least, the Bank of Japan, for its part, will also continue with its efforts to contribute to improving financial literacy through supporting the activities of the Central Council for Financial Services Information. Thank you for your attention. Financial Literacy: Money Management for Creating a Life of Well-Being February 14, 2020 AMAMIYA Masayoshi Deputy Governor of the Bank of Japan Bank of Japan Chart 1 Financial Literacy Survey True/false questions on "financial knowledge and financial decision-making skills" Questions on "characteristics of behavior and attitude" If interest rates rise, what will typically happen to bond prices? I set long-term financial goals and strive to achieve them. 1. They will rise 2. They will fall 3. They will stay the same 4. There is no relationship between bond prices and interest rates Agree Disagree 5. Don't know Chart 2 Correct answers to true/false questions Nationwide average: 56.6% (2016 survey: 55.6%) By region By age group % % Age18-29歳 18-29 30s 30歳代 2016年 2019年 40s 50s 60s 70s 40歳代 50歳代 60歳代 70歳代 2016年 2019年 Chart 3 Correct answers (2): International comparison OECD Survey (11 common questions) Questions with relatively low percentage of correct answers in Japan Finland フィンランド France フランス New Zealand ﾆｭｰｼﾞｰﾗﾝﾄﾞ Norway ノルウェー Kong (China) [5] Hong 香港（中国） Austria オーストリア Belgium ベルギー Canada カナダ Portugal ポルトガル [10] South Korea 韓国 Inflation (true/false question): "High inflation means that the overall cost of living is increasing rapidly" Compound interest: "Suppose you put 1 million yen into an account with a guaranteed interest rate of 2% per year. If no further deposits or withdrawals are made, how much would be in the account after 5 years (disregarding tax deductions)?" ・ ・ ・ Japan 日本 ・ ・ ・ Diversified investment (true/false question): "Buying a single company's stock usually provides a safer return than a stock mutual fund (a financial product for investing in stocks of several companies)" ・ ・ ・ ・ ・ ・ % Source: OECD (2016), OECD/INFE International Survey of Adult Financial Literacy Competencies. Chart 4 High scores vs Financial trouble Percentage of correct answers and proportion of respondents who had experienced financial trouble cases Those who experienced financial trouble (%), nationwide average: 6.7 (Reference) Damage caused by special fraud 20,000 18,000 Amount of damage caused by special fraud (right scale) 100 mil. yen 16,000 14,000 12,000 10,000 8,000 6,000 4,000 Number of recorded cases of special fraud (left scale) 2,000 Correct answers (%), nationwide average: 56.6 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: National Police Agency, Cases of Special Fraud Reported and Arrested, 2018 (Final Figures). Chart 5 Investment stance Risk-taking stance Money investment Suppose that, if you invested 100,000 yen, you would get either of the following at a 50% probability: - a capital gain of 20,000 yen, or - a capital loss of 10,000 yen. What would you do? Have you ever invested an amount of money that exceeded your monthly living expenses? When you invested such an amount in a financial product most recently, did you compare it with other financial institutions' products or other types of financial products in order to choose one that was considered to be the most beneficial? % % I would invest, 22.7 (21.4) I would not invest, 77.3 (78.6) I invested such an amount of money after making comparisons, 17.1 (15.6) I have not invested such an amount of money, 74.5 (75.2) Note: Figures in parentheses represent the results of the 2016 survey. I invested such an amount of money without making any comparison, 8.4 (9.2) Chart 6 Investment stance (Survey on Household Finances) To what extent do you intend to hold financial products that have a risk of falling below par, but are expected to be profitable, over the next one or two years? Two-or-more-person households 2010 1.7 2010年 13.6 2011 1.3 2011年 13.9 2012 1.5 2012年 12.5 2013 1.7 2013年 14.1 2014 1.9 2014年 15.4 2015年 2015 1.8 16.4 2016年 2016 2.1 15.3 2017年 2017 2.0 15.4 2018年 2018 2.5 15.6 2019年 2019 2.2 17.4 40% 0% 83.2 83.2 82.9 82.9 84.5 84.5 82.6 82.6 81.5 81.5 80.2 80.2 80.7 80.7 80.8 80.8 80.5 80.5 78.9 60% 20% 78.9 80% 40% 1.5 2010年 8.6 1.9 2011年 1.5 Single-person households 2010年 8.6 27.6 1.9 2011年 27.6 2012年 7.6 29.8 1.5 2012年 7.6 29.8 1.6 2013年 9.7 26.8 1.6 2013年 9.7 26.8 1.2 2014年 10.2 25.8 1.2 2014年 10.2 25.8 1.6 2015年 10.5 25.7 1.6 2015年 10.5 25.7 1.9 2016年 25.2 1.9 2016年 25.2 1.8 2017年 9.8 1.8 2017年 9.8 1.4 2018年 10.8 1.425.7 2018年 10.8 25.7 1.5 2019年 11.4 1.5 27.4 2019年 11.4 27.4 100% 60% 0% 80% 1.5 20% 100% 100 % 40% 0% 60% 20% 61.4 61.4 64.4 64.4 62.6 62.6 63.5 63.5 63.9 63.9 63.8 63.8 64.9 64.9 64.3 64.3 63.5 63.5 61.2 61.2 80% 40% I intend to hold such I intend to hold such I have no intention of そうした商品を No answer そうした商品についても、 そうした商品についても、 そうした商品を 無回答 そうした商品についても、 そうした商品についても、 products proactively. products to some extent.一部は保有しようと思っている holding such products. 保有しようとは全く思わない 積極的に保有しようと思っている 一部は保有しようと思っている 保有しようとは全く思わない 積極的に保有しようと思っている 100% 60% 80% 無回答 100% % Chart 7 Funds for retirement Percentage of respondents with a financial plan for "living expenses for retirement" Understanding of one's own public pension (those in their 50s) % Receivable amount 受け取れる金額 37.4 62.6 48.7 51.3 年金受給の Required number of years必要加入期間 of payment 49.3 50.7 年金の支給 Age of starting to 開始年齢 receive the pension 50.5 49.5 加入している Category of public 公的年金の種類 pension Age group 20代 18-29 知らない I don’t know Category被保険者と of insured person しての種類 知っている I know 30s 30代 40s 40代 2016年 50s 50代 60s 60代 2019年 70s 70代 71.2 28.8 % 100 ％ Chart 8 Effects of financial education Those who exhibited desirable financial behavior (%), average of all samples: 59.5 Correct answers and behavior by occupation/age group Participated in financial education Adults (age 30–59) Young adults (age 18-29) Did not participate in financial education Senior citizens (age 60-79) Average of all samples Students (age 18-24) Teachers Correct answers (%), average of all samples: 56.6 Chart 9 Experience of financial education Financial education at school, etc. Financial education at home Was financial education offered at your school or college, or at your workplace? Did your parents or guardians teach you how to manage your finances? 70s 1.4 6.5 70歳代 84.2 7.8 70s 70歳代 18.3 71.4 10.3 60s 1.65.8 60歳代 83.9 8.6 60s 60歳代 18.3 70.3 11.4 50s 1.2 6.6 50歳代 79.5 12.7 50s 50歳代 18.4 66.5 15.1 40s 1.45.3 40歳代 75.7 17.6 40s 40歳代 18.4 62.7 18.9 30s 1.8 7.3 30歳代 70.6 20.4 30s 30歳代 21.5 57.5 21.0 3.3 12.5 Age 18-29 (2.7) 18-29歳 (10.7) 53.7 (56.1) 0% 30.5 (30.5) Age 18-29 18-29歳 100 % 20% 40% 60% 80% 100% Yes, but I did not participate in the financial education offered 受ける機会はあったが、自分は受けなかった Yes, and I did participate in the financial education 受ける機会があり、自分は受けた No 受ける機会はなかった わからない Don't know 28.2 (26.6) 0% 20% Yes 機会はあった Note: Figures in parentheses represent the results of the 2016 survey. 43.5 (43.3) 40% 28.4 (30.2) 60% No 機会はなかった 80% 100 % 100% Don't know わからない Chart 10 Tools for financial education Pamphlets for respective age groups High school students University students 10 thous. Adults PR magazine Kurashi-juku Kin’yu-juku (“First steps toward financial literacy for everyday life”) Number of page views Primary and secondary school students Website of the Central Council for Financial Services Information 8 10 12 2 8 10 12 2 8 10 121
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Speech by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the Kin'yu Konwa Kai (Financial Discussion Meeting), hosted by the Jiji Press, Tokyo, 30 January 2020.
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January 30, 2020 Bank of Japan Interest Rate Benchmark Reform in Japan Speech at the Kin′yu Konwa Kai (Financial Discussion Meeting) Hosted by the Jiji Press AMAMIYA Masayoshi Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Good afternoon, everyone. It is my pleasure to have the opportunity to speak to you today about the interest rate benchmark reform. The term "interest rate benchmark" may not sound familiar to those who are not engaged in financial businesses. It refers to a rate that reflects the prevailing market rates and serves as the base rate when determining the price of financial transactions. The most famous and widely used interest rate benchmark around the world is the London Interbank Offered Rate, or LIBOR, which is calculated based on the interest rates of interbank transactions in London. LIBOR is presently published for seven tenors ranging from overnight to 12 months, and for five currencies: the U.S. dollar (USD), British pound (GBP), Euro (EUR), Swiss franc (CHF), and Japanese yen (JPY). There are other interest rate benchmarks based on interbank offered rates, such as TIBOR, which is the Japanese yen interest rate benchmark published in Tokyo, and the EURIBOR, which is the Euro benchmark published in the Euro area. Recently, we have also seen the publication for major currencies of overnight interest rate benchmarks called "risk-free rates," which are literally interest rates that are not affected by credit risk. Interest rate benchmarks are actually used in large volume and a broad range of financial transactions including loans, bonds, and derivatives (Figure 1). Accordingly, interest rate benchmarks impact the pricing of various financial transactions and affect, through investment and funding activities, the economic activities of a wide range of relevant parties including banks and non-financial corporates. Therefore, it is clear that interest rate benchmarks are extremely important, but it is very likely that LIBOR, which is widely used around the world, will be phased out at the end of 2021. I will explain the background to the possible discontinuation of LIBOR in detail later. In the meantime, an urgent issue we now face is to ensure the formation of fair prices in financial markets and the stability of financial transactions, including corporate finance, even after the discontinuation of LIBOR. Given those circumstances, "interest rate benchmark reform" has been discussed in many countries, including Japan, in terms of how to select alternative interest rate benchmarks that will replace LIBOR and how to transition smoothly to those benchmarks. The current framework for interest rate benchmarks, which is centered on LIBOR, has become firmly established in the financial system over time. Therefore, it is undoubtedly challenging to design and realize a new framework for interest rate benchmarks that will replace the current one. Through the interest rate benchmark reform efforts to date, we can see the direction of preparations for the discontinuation of LIBOR as well as the development of a new framework. However, there is less than two years until that will happen. That is not a long time considering the extent and complexity of the challenges for the transition from LIBOR to alternative benchmarks. It is also difficult to say that the awareness of those issues is being shared fully among the relevant parties. During that limited time, proactive efforts will be required not only by financial institutions but also a wide range of relevant parties, including non-financial corporates. Today, while looking back on the events leading up to the current situation, I would like to explain the efforts that will be required during the next two years until the end of 2021, when it is expected that LIBOR will be discontinued, and what we should achieve through the interest rate benchmark reform. I. Background Origin of LIBOR and the expansion of its use First, I would like to reflect on the historical background that led to the widespread use of LIBOR today. The origin of LIBOR dates back to the late 1960s. At that time, partly due to U.S. regulations on deposit interest rates and capital outflows, holders of USD funds in the United States and abroad moved their funds into an offshore market -- the Euro-dollar market in London. Under those circumstances, in order to respond to the various demands for USD funds in international financial markets, new methods of lending were created such as risk diversification through syndicated loans and control of interest rate risk through floating rate loans. In doing so, a convention was established to set the base rate of loans as the average funding rate of offshore USD deposits by banks participating in syndicated loans. This was the origin of LIBOR. In 1986, the British Bankers′ Association began publishing the "BBA LIBOR" for three currencies: the USD, GBP, and JPY. That was the official start of LIBOR. LIBOR is calculated and published in accordance with a prescribed process based on rates submitted by multiple predetermined banks called panel banks. That mechanism has made LIBOR highly convenient and allowed it to be published for as many as 10 currencies at its peak.1 At that time, LIBOR was regarded as the de facto risk-free rate reflecting the prevailing market rates. That was because, first, highly credible banks were selected as panel banks, and second, LIBOR panel banks were required to submit the funding rate of a prime bank (a bank with particularly high creditworthiness) judged by each panel bank rather than their own funding rates. By being positioned in this way, LIBOR was used not only as the base rate of loans but also to determine the issuance terms of bonds. Furthermore, as derivative transactions expanded with the development of financial technology, LIBOR began to be used as a reference for interest rate swap transactions and other transactions. Under these circumstances, the position of LIBOR as an interest rate benchmark was solidified further. Further expansion of LIBOR′s use It is common for LIBOR to be used not only for such financial transactions but also as the transfer price among internal departments within companies including financial institutions. LIBOR has also come to be used for the mark-to-market valuation of financial products and as historical data to manage interest rate risk. In addition, LIBOR is sometimes used in frameworks for accounting standards such as hedge accounting. In this way, LIBOR is now being used in various areas, forming an infrastructure that supports the entire financial system from the perspective of interest rates. In view of the success of LIBOR, in Japan, the Japanese Bankers Association started calculating and publishing TIBOR in a similar framework in 1995. Moreover, even for While LIBOR was also published for the Canadian dollar, Australian dollar, New Zealand dollar, Danish krone, and Swedish krona, it was discontinued in one case after another in 2013. currencies not covered by LIBOR, interest rate benchmarks began to be calculated and published in similar frameworks, such as HIBOR in Hong Kong and SHIBOR in Shanghai. Global financial crisis In the midst of the widespread use of LIBOR, the global financial crisis occurred in the late 2000s. As mentioned earlier, while LIBOR came to be used widely as a de facto risk-free rate, banks, which are private economic entities, inherently have embedded their own credit risk in the interest rates for interbank transactions. At the time of the global financial crisis, the banks′ credit risk was recognized in light of the possibility of bank failures, and LIBOR rose sharply as a result (Figure 2). At the same time, against the backdrop of mutual distrust among market participants, we saw substantial shrinkage in the unsecured money market among banks, which was the basis for LIBOR panel banks in determining the submission rates. In 2012, it came to light that some panel banks had submitted fraudulent rates during the global financial crisis. Going back to 1998, the submission rates of panel banks were changed to the banks′ own funding rates, while, as mentioned earlier, those rates were originally the funding rates of prime banks. A decade later, as the credit risk of banks inherently embedded in LIBOR came to the surface with the occurrence of the global financial crisis, some banks submitted fraudulent rates for their own benefit, such as making it appear as though their creditworthiness was higher than it actually was. As a result, the reliability of LIBOR as an interest rate benchmark started to be seriously questioned. Toward interest rate benchmark reform Given that LIBOR is widely used in a range of areas, a decrease in its reliability would give rise not only to concerns about the formation of fair prices in financial markets, including the derivative market, but also could threaten financial stability due to LIBOR′s influence on corporate financing through debt instruments such as loans and bonds. As a result, there have been calls for initiatives to secure the robustness of interest rate benchmarks to prevent such fraudulent manipulation and to restore the reliability of interest rate benchmarks, including LIBOR. These initiatives are referred to as the "interest rate benchmark reform" (Figure 3). The impact of the attempted market manipulation and false reporting of LIBOR was so significant that the issue was discussed at the G20 St. Petersburg Summit in September 2013. To restore the reliability of interest rate benchmarks, the G20 endorsed the Principles for Financial Benchmarks established by the International Organization of Securities Commissions (IOSCO) and requested the Financial Stability Board (FSB) to undertake a fundamental review of major interest rate benchmarks and reform plans. In response, the FSB published a report in July 2014 titled "Reforming Major Interest Rate Benchmarks." The current interest rate benchmark reform is being promoted based on that report. Based on the overarching perspective that benchmark rates should be anchored in actual transactions wherever possible, the FSB report recommended that the reliability and robustness of existing major benchmarks such as TIBOR and EURIBOR, as well as LIBOR, be improved by minimizing the opportunities for market manipulation. Moreover, to respond to the need for benchmark rates without bank credit risk, the report encouraged the development of alternative, nearly risk-free rates that do not include bank credit risk, thereby enabling market participants to choose LIBOR or other benchmark rates depending on the purpose of that use. This policy is called the "multiple-rate approach" because it is intended to allow users to choose from more than one interest rate benchmark and select one that best fits their purpose. Japan has also been affected by LIBOR reform since LIBOR is also calculated for JPY. There has been a need for TIBOR reform and discussions on risk-free rates for JPY. Thus, in response to international discussions, interest rate benchmark reform has become an important and unavoidable issue for Japan. II. Initiatives for Interest Rate Benchmark Reform I would now like to explain the initiatives for interest rate benchmark reform that have been taken to date by dividing them into two phases. First phase In response to international discussions, each jurisdiction has proceeded with reforming existing benchmarks such as LIBOR, TIBOR, and EURIBOR, and the use of risk-free rates to be calculated based on the actual transaction rates for overnight fund transactions has been discussed. This was the first phase of the interest rate benchmark reform. The first reform implemented in Japan was the reform of TIBOR, which was widely used as the interest rate benchmark for domestic loan transactions and other transactions. TIBOR used to be published by the Japanese Bankers Association, but the JBA TIBOR Administration was established in April 2014 to develop a more independent and neutral administration framework for TIBOR and it took over the calculation and publication of TIBOR. Moreover, in May 2015, it became apparent that TIBOR was subject to regulations of the Japan Financial Services Agency (JFSA) as a Specified Financial Benchmark under the Financial Instruments and Exchange Act. In July 2017, the rates to be submitted started to be calculated in accordance with a standardized and clarified calculation and determination process. At the same time, discussions on the JPY risk-free rate were held by the Study Group on RiskFree Reference Rates, which was launched in April 2015. In December 2016, the study group identified the "uncollateralized overnight call rate," which is calculated and published by the Bank of Japan, as the JPY risk-free rate. Second phase While each jurisdiction, including Japan, was promoting interest rate benchmark reform, Chief Executive Andrew Bailey of the U.K. Financial Conduct Authority (FCA) delivered an important speech in July 2017 in which he strongly suggested the possibility of the permanent discontinuation of LIBOR at the end of 2021.2 He pointed out that the framework for LIBOR might not be sustainable under circumstances where many panel banks were feeling discomfort about providing submissions given the inactive transactions in the underlying interbank unsecured money market. On the other hand, the unexpected and unplanned disappearance of LIBOR due to the withdrawal of panel banks would be unacceptable. Therefore, the FCA requested the current panel banks for their commitment to continue submitting rates until the end of 2021, and it encouraged market participants in the transition from LIBOR to alternative benchmarks in the interim. Bailey, Andrew (2017) "The future of LIBOR," available at https://www.fca.org.uk/news/speeches/the-future-of-libor. Even if LIBOR is discontinued, TIBOR and EURIBOR will continue to be published for JPY and EUR, resulting in the co-existence of those benchmarks and risk-free rates. However, for the USD and other currencies, there will be no comparable benchmarks once LIBOR ceases to exist, and the only option will be to transition to risk-free rates (Figure 4). In any case, the speech by Chief Executive Bailey shifted the main focus of interest rate benchmark reform to the planning and development of a new framework for interest rate benchmarks and a seamless transition to that framework after the discontinuation of LIBOR, which is considered to be a shift to the second phase of reform. The first step in that phase is to examine alternative benchmarks to replace LIBOR. It is also necessary to modify the language in existing contracts that refer to LIBOR well in advance to ensure smooth transactions after the discontinuation of LIBOR. These activities are being examined by applying different approaches according to the type of financial product or transaction. First, for derivative transactions, the International Swaps and Derivatives Association (ISDA), which develops a standard contract for such transactions, is promoting global efforts to modify the standard contract for derivatives while consulting with market participants. On the other hand, for "cash products" such as loans and bonds, unlike derivative transactions, there is no standard contract that is widely used internationally. Accordingly, each jurisdiction needs to take measures to deal with the discontinuation of LIBOR in those transactions. In this regard, in Japan, the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks consisting of financial institutions, institutional investors, and non-financial corporates was established in August 2018, with the Bank of Japan acting as the secretariat, and it has been conducting deliberations. Last summer, as a key milestone in the committee′s work, a public consultation was held on the appropriate choice of alternative benchmarks to JPY LIBOR. During that consultation, many comments were provided on the issues presented by the committee from a wide range of relevant parties, including non-financial corporates. As a result of that public consultation,3 a "term reference rate," which would be calculated based on future expectations of the Japanese risk-free rate (uncollateralized overnight call rate), received the most support as an alternative benchmark to JPY LIBOR for both loans and bonds (Figure 5). There are several reasons for the strong support for the term reference rate: it is not affected by bank credit risk; it would be "fixing in advance" like LIBOR, which would allow users to determine the base rate before entering transactions; and it is highly compatible with current conventions and operations. It is expected that the initiatives toward a transition to the term reference rate will be promoted for transactions that currently use JPY LIBOR. Deliberations outside of Japan What are the developments of discussions outside of Japan to deal with the possible discontinuation of LIBOR for loans and bonds? In the United States and the United Kingdom, for example, with respect to certain loans, it seems some market participants have indicated that they want to use term reference rates for each currency. Meanwhile, given that term reference rates have not yet been developed sufficiently, financial authorities are strongly encouraging the use of compounded overnight risk-free rate fixing in arrears rather than waiting for the development of term reference rates. This stance by the U.S. and the U.K. authorities represents the urgency with which they are promoting a timely transition from LIBOR to alternative benchmarks in light of the limited time until the end of 2021. III. Why is the Reform Challenging? Even in the United States and the United Kingdom, where the reform has been promoted, smooth transition from LIBOR is considered a challenging project given the time limit of the end of 2021. Now, I would like to explain why interest rate benchmark reform is not easy in any jurisdiction, including Japan. What I am going to talk about is related to the essence of Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks (2019) "Final Report on the Results of the Public Consultation on the Appropriate Choice and Usage of Japanese Yen Interest Rate Benchmarks," available at https://www.boj.or.jp/en/paym/market/jpy_cmte/data/cmt191129b.pdf. the issues embedded in interest rate benchmarks; therefore, sharing the following three points should help ensure the achievement of the ongoing reform. First, as there are various needs for the relevant parties in financial transactions, it is necessary to identify an interest rate benchmark as a common infrastructure. As I have already mentioned, LIBOR was created based on the needs of market participants. It was designed to be used with ease in various transactions, such as loans and bonds, and it became the standard benchmark interest rate. In other words, an alternative interest rate benchmark should be one that is accepted by a wide range of relevant parties for their financial transactions. Second, once adopted for use in various financial transactions, the interest rate benchmark tends to become deeply rooted in the overall financial system as market practices. This characteristic is called network externality embedded in interest rate benchmarks. Taking LIBOR as an example, the greater the number of market participants that select LIBOR, the more liquid transactions using LIBOR become, which increases the merits of using LIBOR in terms of transaction costs and causes the use of LIBOR to expand further. Moreover, as LIBOR becomes widely referred to in risk management and transaction practices, various areas in financial transactions will become mutually dependent through LIBOR. Under these circumstances, if we are to change from LIBOR to another interest rate benchmark, it will be necessary to proceed with that transition in a consistent manner across all relevant areas. In other words, a project aiming to transition away from LIBOR to alternative benchmarks requires that a lot of work should proceed simultaneously, thereby increasing the difficulty of the reform as a large-scale project that involves a large number of relevant parties. Third, global coordination is also vital for interest rate benchmark reform. Since interest rate benchmark reform presumes the discontinuation of LIBOR and takes the approach of selecting alternative benchmarks for each currency, specific deliberations will be left to each jurisdiction. As a result, the status of alternative benchmarks might differ from currency to currency, depending on the situation of the financial markets in each jurisdiction. Nevertheless, in order to ensure smooth cross-border transactions, it is necessary to coordinate the use of interest rate benchmarks on a global scale to a certain extent. Ensuring global coordination among interest rate benchmarks used for cross-currency swap transactions is important. These three things indicate the basic viewpoints of the interest rate benchmark reform. The following points are considered to be important: endeavoring to form a consensus on the selection of interest rate benchmarks as a common infrastructure by taking various needs of parties into account; involving many relevant parties in the reform given that interest rate benchmarks tend to become deeply rooted in the financial system; and furthermore, ensuring that the interest rate benchmark reform of each jurisdiction is in line with global trends. IV. Japan′s Initiatives for a Smooth Transition from LIBOR Now, I would like to discuss how Japan should proceed with interest rate benchmark reform over the next two years until the end of 2021, when the discontinuation of LIBOR is expected. I will focus on initiatives by individual companies, initiatives by the entire market, and the role of the public sector. Initiatives by individual companies The users of interest rate benchmarks such as financial institutions, institutional investors, and non-financial corporates are required to change their LIBOR-based operations and organizational structures to a framework based on alternative benchmarks (Figure 6). In this regard, it is important first of all to accurately understand how those parties use LIBOR, because this might be different depending on the industry type and the business model of individual companies. It is also necessary to not only simply examine the exposure of LIBORbased transactions but also how LIBOR is used in various areas, including accounting and risk management. While the workload associated with the detailed research might be heavy in some cases, it is essential to conduct a thorough examination given the widespread use of LIBOR as a market practice. In addition, it will be required to establish a governance framework, including specific section focusing on the transition to alternative benchmarks, and secure internal resources, including staff and budgets, while the extent of the preparation may differ from one institution to another. It is also expected that internal systems and operations will be reviewed depending on the status of the use of LIBOR. Moreover, it is necessary to execute agreements between lenders and borrowers to revise loan contracts. We should therefore keep in mind that it will take considerable time to fully implement the measures necessary for the transition to alternative interest rate benchmarks. In this regard, since financial institutions function as the "hub" of financial transactions, they are expected to provide in a timely manner accurate information to their clients, the users of the interest rate benchmarks, on how to deal with each transaction, and to take the lead in taking necessary measures for reviewing LIBOR-based transactions. Market-wide initiatives It is also important to promote market-wide initiatives, including the establishment of alternative benchmarks to LIBOR and the development of market practices, in order to encourage individual actions by market participants and interest rate benchmark users (Figure 7). As mentioned earlier, for the Japanese yen, there is a great deal of support for the term reference rate to be used as an alternative benchmark to JPY LIBOR. The entity responsible for calculating and publishing the term reference rate is scheduled to be determined relatively soon. As a first step, the entity is going to start publishing "prototype rates," which do not presume use in actual transactions. Through the publication of prototype rates, it is expected that the entire market will transition smoothly from JPY LIBOR to the term reference rate as individual steps are taken to prepare for transactions using that alternative benchmark. Following that, the aim is to publish "production rates" of the term reference rate no later than mid-2021, with an assumption that these will be used in actual transactions. In addition, it is necessary to review market practices that have been developed based on LIBOR. If a risk-free rate without bank credit risk is used as an alternative benchmark, the characteristics of the base rate will differ from those of the current base rate. Moreover, while LIBOR is published based on the rate at 11:00 a.m. London time, in the future, alternative benchmarks of each currency would be published in each jurisdiction, which will have a certain impact on transaction practices because of factors such as differences in the publication times of each benchmark. In any case, it is necessary to examine market practices, including those issues. Role of the public sector In relation to initiatives by individual companies and the entire market, it is important for the public sector to have the perspective of ensuring the formation of fair prices and the stability of financial transactions in financial markets both before and after the discontinuation of LIBOR (Figure 8). Therefore, with respect to initiatives by individual companies, it is necessary to strongly encourage financial institutions to take specific actions. In this regard, we at the Bank of Japan, have conducted a joint survey recently with the JFSA regarding financial institutions′ status of using LIBOR and governance framework. In addition, with respect to market-wide initiatives, it is important for the public sector to concurrently play the role of a coordinator and a facilitator. For the ongoing interest rate benchmark reform, the public sector needs to simultaneously review various frameworks and practices that have been developed based on LIBOR. It also needs to proceed with that complex process while coordinating the different viewpoints of a diverse range of parties. As the central bank and the secretariat of the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks, the Bank of Japan continues to support interest rate benchmark reform from those perspectives while simultaneously cooperating with the JFSA. Toward the end of 2021 In taking the various measures mentioned to this point, it is very important for both the private and public sectors to keep in mind the timeline of when the discontinuation of LIBOR is expected; that is, up to the end of 2021. Going forward, given the magnitude of work, including reviewing the operations of individual companies, responding to clients, and reviewing market practices, two years is by no means a long time. In order to accomplish the interest rate benchmark reform by also utilizing the results of past deliberations, it is necessary for all relevant parties in the private and public sectors to steadily implement measures while appropriately cooperating with each other by keeping in mind the limited time until the end of 2021. Closing Remarks: Improving the Attractiveness of Tokyo′s Financial Markets As explained so far, the private and public sectors must cooperate with each other to seriously tackle the common goal of transitioning to a new framework for the interest rate benchmark that will replace LIBOR. Lastly, I would like to discuss what we should aim for by achieving the interest rate benchmark reform through considerable efforts and substantial costs to be borne by the relevant parties, including those of you who are here today. Interest rate benchmarks are an important infrastructure with which economic entities engage in financial and economic activities. It can be said that developing interest rate benchmarks for the Japanese yen that will continue to function even after economic or financial shocks, as well as remain "reliable" and "robust" without any room for fraudulent manipulation, is an indispensable element in maintaining the stability of the financial system in Japan. I believe the construction of a highly reliable and robust interest rate benchmark will strengthen the functions of Tokyo′s markets along with the infrastructure of existing financial markets, which will lead to the improvement of the attractiveness of Tokyo′s markets as international financial markets and the mother market of the Japanese yen (Figure 9). There are many examples even within the limited area of market practices where initiatives to boost the attractiveness of Tokyo′s financial markets can be seen. As a part of those initiatives, I would like to mention that the settlement cycle of JGBs has been shortened as the internationalization of the Japanese yen and the globalization of securities transactions has been advocated since the 1990s. This has contributed to improving the attractiveness of the JGB market in terms of both reducing the settlement risk by shortening the settlement cycle and improving the convenience by quickly liquidating JGBs. After the coordinated and continued efforts among market participants, market infrastructure institutions, and the public sector over a long period, in May 2018, the JGB settlement cycle became T+1 and accompanying market practices were developed. Moreover, in the stock market, the JFSA established Japan′s Stewardship Code in February 2014 while the Tokyo Stock Exchange established the Corporate Governance Code in June 2015. Through these efforts, we have achieved a constructive "purposeful dialogue" between institutional investors and invested companies; namely, the deepening of engagement and strengthening of the governance of listed companies. In addition, for the foreign exchange market, the FX Global Code was published in May 2017, and this compiled action principles for market participants to follow. Tokyo′s markets have received statements of commitment from many market participants and boast a large number of ratifications among the foreign exchange markets in countries around the world. It can be said that this demonstrates a strong sense of discipline by Tokyo market participants themselves, which seems to contribute to increasing the confidence in Tokyo′s market. Going forward, as the globalization and digitalization of economies and finance proceeds, the strengthening of the function of Tokyo′s markets to boost their attractiveness as international financial markets will lead to firmly supporting the development of the Japanese economy from the financial side. The Bank of Japan will work not only to tackle interest rate benchmark reform but also develop the infrastructure of financial markets in various areas. Thank you very much for your attention. Interest Rate Benchmark Reform in Japan Speech at the Kin'yu Konwa Kai (Financial Discussion Meeting) Hosted by the Jiji Press January 30, 2020 Deputy Governor of the Bank of Japan AMAMIYA Masayoshi Figure 1 Widespread Use of LIBOR Assets referencing JPY LIBOR Outstanding volume of transactions referencing key IBORs (tril. yen) (triｌ. U.S. dollars) Currency USD LIBOR Asset Class Volume Loans GBP LIBOR CHF LIBOR 6.5 EUR LIBOR JPY LIBOR Ref. EURIBOR Ref. TIBOR Bonds OTC Derivatives Volume Corporate loans (bilateral) Syndicated loans Floating rate notes IR swaps 2,453 Swaptions Basis swaps Cross-currency swaps Source: FSB "Final Report of the Market Participants Group on Reforming Interest Rate Benchmarks" (March 2014). Figure 2 Sharp Rise of LIBOR in the Global Financial Crisis 3-month USD LIBOR ％ BNP Paribas shock Failure of Lehman Brothers Note: The latest data as of December 31, 2019. Source: Bloomberg. Year Figure 3 Toward Interest Rate Benchmark Reform Decrease in the reliability of LIBOR, which has been widely used in various areas Concerns over smooth pricing in financial markets, including the derivative market Influence on corporate financing through loans and bonds Potential threat to financial stability Interest Rate Benchmark Reform Restore the reliability of interest rate benchmarks Secure robustness to prevent fraudulent manipulation Direction of Interest Rate Benchmark Reform Figure 4 USD SOFR （Secured Overnight Financing Rate） EUR JPY €STR （Euro Short-Term Rate） TONA (Uncollateralized overnight call rate, Tokyo Overnight Average rate) EURIBOR TIBOR ・・・ Risk-free rates identified in each currency ・・・ Existing interest rate benchmarks that include bank credit risk Results of Public Consultation on the Appropriate Choice and Figure 5 Usage of Japanese Yen Interest Rate Benchmarks （excerpt） Options for alternative benchmarks to JPY LIBOR Loans Bonds Compounded average of the uncollateralized O/N rate 8% TIBOR 30% TIBOR 5% Compounded average of the uncollateralized O/N rate 37% Term Reference Rates 62% Term Reference Rates 58% To be published by mid-2021 Note: Multiple answers allowed. Comments from industry groups are regarded as one opinion regardless of the number of members in the group. Figure 6 Initiatives by Individual Companies Understand the status of using LIBOR • Identify specific financial instruments and transactions referencing LIBOR • Identify operations using LIBOR other than financial transactions （e.g., accounting and risk management） • Establish a specified section dedicated to the transition to an alternative interest rate benchmark Develop systems and secure internal resources • Secure internal resources, including staff and a budget ⇒ It should be noted that it will take considerable time to review systems and operations and revise loan contracts. Figure 7 Planned Market-Wide Initiatives Expected discontinuation of LIBOR after end-2021 Item 3Q Publication of prototype rates for Term Reference Rates （Phase 1） Publication of production rates for Term Reference Rates （Phase 2） 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q To be published around the first quarter of 2020 To be published no later than mid-2021, (while making best efforts to move the schedule forward) Figure 8 Role of the Public Sector Support by the Bank of Japan and the Japan Financial Services Agency ＜Encourage financial institutions to take measures＞ ＜Coordinate different viewpoints of a diverse range of parties＞ Initiatives by individual companies Market-wide initiatives e.g., BOJ and JFSA conducted a joint survey regarding the status of using LIBOR, etc. by financial institutions e.g., BOJ serves as the secretariat of the Committee, playing the role of coordinator and facilitator. Secure smooth pricing in financial markets and the stability of financial transactions Figure 9 Improving the Attractiveness of Tokyo's Financial Markets Initiatives to improve the functions of important infrastructure for economic entities to engage in financial and economic activities Initiatives for interest rate benchmark reform Examples of other initiatives Bond Market Equity Market FX Market 2018：Shortening of the JGB settlement cycle to T+1 2014：Japan's Stewardship Code 2015：Japan's Corporate Governance Code 2017：FX Global Code Improving the attractiveness of Tokyo's markets as international financial markets and Japanese yen's mother market 9■
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Remarks by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the Future of Payments Forum, Tokyo, 27 February 2020.
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Masayoshi Amamiya: Central Bank Digital Currency and the future of payment and settlement systems Remarks by Mr Masayoshi Amamiya, Deputy Governor of the Bank of Japan, at the Future of Payments Forum, Tokyo, 27 February 2020. * * * Introduction I would like to thank all of you for attending the Future of Payments Forum today. Recent private sector initiatives, including stablecoins, indicate the customers’ need for convenient, fast and efficient payments. To meet this need, the central bank should cooperate with the private sector and continue to improve the payment and settlement infrastructures it offers. In this regard, the question as to whether the central bank should issue digital currency (CBDC) or not has become an important issue. When we look into how we should picture the future of payment and settlement infrastructures in Japan, in a digital society, it is important to consider in what forms the central bank should provide central bank money, and how to improve the private sector’s payment services. These two issues are closely related and should not be examined separately. I sincerely hope that we will have a fruitful exchange of views, as we have so many experts here today at the Future of Payments Forum. When addressing these issues, it is important to explore how IT innovations and private sector initiatives could impact the payment and settlement systems and the architecture of money. To initiate our discussion, I would first like to touch upon “what will remain unchanged” and “what will change” in the foreseeable future. What Will Remain Unchanged There are three things that will not change or should not be changed regarding the payment and settlement systems, and money. First, the basic architecture of money will remain unchanged. There are two forms of money: token-based or account-based. Token-based money is a form of money in which monetary value is locally stored in some kind of media. Cash and electronic money issued by Japanese transport companies are examples. There is a difference in the type of media in which monetary value is stored, i.e. paper and electronic devices, but the basic architecture remains the same where payments are made by transferring the monetary value stored in that media. Meanwhile, the transfer of value of an account-based money occurs when the issuer debits the account of the payer and credits the account of the payee, upon receiving the value transfer instruction from the payer. A typical example of account-based money is bank deposits. There are a number of ways for a payer to send a bank transfer instruction to his or her bank, such as via bank teller counters, internet banking, credit and debit cards, but the basic architecture remains the same. Nonbank payment service providers (NBPSPs), who are leading today’s expansion of the cashless society in Japan, also issue account-based money. Users send them value transfer instructions against their accounts via smartphones to make payments. The future payment services will likely develop based on either of these two forms: token-based money or accountbased money. Second, the two-tiered monetary system will remain unchanged. This is something that should not be changed and should be maintained. The two-tiered system is a system where the central bank exclusively supplies central bank money consisting of cash and central bank deposits, and 1/4 BIS central bankers' speeches private banks provide deposits through credit creation based on the central bank money. Under the two-tiered system, financial resources are efficiently distributed through private-led initiatives, and the system has the advantage of fully utilizing the private innovation in payment services. Indeed, money issued by NBPSPs, such as Fintech firms, whether token-based or accountbased, is created through the equivalent conversion of cash or bank deposits. The existence of a large number of private money issuers will maintain the benefits of competition in the provision of new and efficient means of payments, and in general, of financial services. Third, the fundamental roles of the central bank will remain unchanged. Even if the use of bank notes were to continue to decline and the Japanese economy became cashless, the central bank would conduct monetary policy under the two-tiered monetary system by controlling central bank current accounts, which is digital money, and act as the “lender of last resort.” The central bank may face challenges, such as monetary transmission channels becoming more complex or getting a grasp of money becoming more difficult. However, these challenges are not new to us. The central bank’s responsibilities and ability to maintain monetary and financial stability will basically be maintained, regardless of the kinds of changes that take place in the environment surrounding payment services and money as IT innovations advance. What Will Change By contrast, how will the payment and settlement systems evolve along with IT innovations? Now, I would like to touch upon three things that will change, and which will be relevant to my later remarks. First, cashless payments will steadily expand in retail payments. In fact, the outstanding amount of cash in circulation has been increasing in major advanced economies, except in special cases such as Sweden. In Japan, people using cashless payments seem to have increased since the introduction of the “Point Reward Project for Consumers using Cashless Payment” by the government in October 2019. However, at the same time, the outstanding amount of cash in circulation has also increased by two percent annually. The preference for cash remains surprisingly strong. Having said that, with the emergence of new services and greater awareness of their convenience, the move toward the cashless society will not be hampered in the long run. Second, diversification of payment service providers is likely to continue. A recent development of the cashless society seems to be led by NBPSPs such as Bigtechs, Fintechs, retailers and transport companies, rather than banks. For example, funds transfer service providers, typically named “XYZ Pay,” and prepaid payment instruments issuers, such as retailers and transport companies, issue digital money that differs from traditional cash and bank deposits, and the use of such digital money seems to be expanding. Diversification of payment service providers will likely have various impacts on financial regulations as well as the operations of payment and settlement systems operated or managed by the central bank and the private sector. Third, money and data will become more closely linked. Many NBPSPs provide convenient cashless payment services. Their aim is not only to improve the convenience of customers, but also to seek to expand their own ecosystem via network effects by inducing customers to use other relevant businesses NBPSPs offer. This strategy is called “Data-Network-Activity (DNA).” In the past, making payments for purchases, in other words, using money, meant an exchange of certain amount of economic value. Nowadays, it also means an exchange of relevant data on who has purchased what, when and where. In some cases, the exchanged data could be data that the web advertisement has just been viewed, but nothing has been purchased. Therefore, when we explore the future of the payment and settlement systems, it becomes more vital to discuss issues concerning the protection and effective use of personal data. CBDC Discussion in Foreign Central Banks In a world where the environment surrounding the payment and settlement systems and money 2/4 BIS central bankers' speeches has been rapidly changing, what roles and functions will be expected for CBDC? Foreign central banks investigating the issuance of CBDC could be put into three groups. The first is the case of Sweden. In Sweden, decrease in the outstanding amount of cash in circulation, having reached less than two percent of GDP, is behind their motivation to explore the possibility of the issuance of CBDC. As a result of a significant growth in cashless payments, the number of retail stores accepting cash has decreased, and people are sometimes facing difficulties doing their daily shopping by cash. Under these circumstances, the central bank is aiming to provide all the people with access to central bank money. The second is the case of emerging economies, such as Cambodia and the Bahamas. In these economies, infrastructures related to domestic currency and payments have remained immature, but smartphones have spread everywhere. In such an environment, rebuilding the payment and settlement systems from scratch is a viable agenda, and it is easier to adopt the latest technology. The third is the case of China. Though details of the design are as yet unknown, according to information officially released up to now, the People’s Bank of China (PBoC) clearly aims at issuing CBDC as a substitute for cash in circulation. The PBoC will not only focus on the reduction of cash handling cost but also on addressing the risks of counterfeiting, as well as preventing money laundering and countering the financing of terrorism (AML/CFT). The situation is different in major advanced economies, including Japan. The need for CBDC is not necessarily increasing, as observed in the aforementioned countries. In many advanced economies, the outstanding amount of cash in circulation is still growing annually. At this point, there is no need to implement new steps to ensure people’s access to central bank money. Moreover, the currency systems and the payment and settlement systems of these economies are operating safely and stably. They cannot simply jump into new technologies, or actually, they should not. AML/CFT is an important issue, but the most advanced economies consider that they should first be addressed through regulatory and supervisory measures. Issues regarding CBDC What, then, will be the roles and functions expected for CBDC, other than those discussed in these cases? To respond to this question, it might be beneficial to review the fundamental roles of the currency. In this way, not only potential benefits of CBDC, but also various issues that need to be addressed will come to light. To support economic activities, it is essential to have payment instruments that are safe, reliable, cheap and universal to everyone. Most would agree that the central bank should play the role of provider of such instruments even in the digital society. CBDC is expected to play a part in this. I would like to share one of the views often expressed by payment service providers. As mentioned earlier, the entry of new service providers into the payments market is one of the key changes in the payment systems arena. In this sense, ensuring the interoperability between private digital money is a challenge. For example, payment platforms operated by NBPSPs, such as “XYZ Pay” do not necessarily share member merchants. In other words, it is often the case that a digital money issued by a NBPSP cannot be accepted by another NBPSP’s member merchant. Similarly, person-to-person (P2P) payments or money transfers cannot be executed between payment platforms operated by different NBPSPs. What roles is CBDC expected to play in these cases? CBDC can help remove barriers of P2P payments and significantly improve the interoperability between different types of private digital money. CBDC can contribute to improving the efficiency of payments by interlinking various types of private digital money. In fact, there seem to be high expectations for CBDC in this respect. 3/4 BIS central bankers' speeches However, the story is not that easy. There are a lot of issues to be considered comprehensively regarding CBDC, including its implications on payment and settlement systems and the overall financial system. As in the cases mentioned earlier, while the issuance of CBDC could contribute to interlinking various types of private digital money, it could also present the risk of crowding out the existing private services, such as bank fund transfers. Moreover, if the payment cost associated with CBDC is much lower than that of private payment services, most of the merchants would prefer to accept payment via CBDC, rather than via the private digital money. The central bank is able to offer services that are cheaper than those offered by private entities because it bears a certain cost from the perspective of providing public goods, that is, the core infrastructure for payment and settlement. Depending on the design and pricing of the core infrastructure, the central bank could suppress private business and discourage innovations. In addition, if firms and individuals preferred holding CBDC to bank deposits, this would affect banks’ funding and the function of financial intermediation, including bank lending. Thus, it could alter the two-tiered monetary system itself. It should be also noted that, as mentioned earlier, as digitalization progresses, money and data will become more closely linked. If the central bank issues CBDC, relevant transaction information will flow into the central bank. Its implication is not only a matter of protecting personal information, but also a matter of what kind of system design is desirable for the society in order to effectively utilize such commercial information for business purposes. The central bank needs to deepen the understanding of the benefits as well as the challenges and risks of issuing CBDC. Moreover, with regard to challenges and risks, the central bank needs to solidly consider whether there are effective measures to address these challenges and risks. There are a wide range of issues. When designing the future of payment and settlement systems, it is important to examine how the overall function of the systems could be improved by considering the interaction between central bank money and private money. In the previous examples, it is important for the private sector to improve the interoperability of payments, improve the efficiency of the existing payment infrastructure, and eliminate friction in the exchange of digital money. To improve interoperability, for example, interlinking different payment platforms or NBPSPs to participate in banks’ payments platform might be an option. Closing Remarks The issues I have just raised are merely some examples relevant to retail payment services. There are also various case examples and challenges concerning wholesale and cross-border payments. In today’s forum, we will hold a session for each of these three topics, retail, wholesale, and cross-border payments. I hope this forum will provide an opportunity to seek out the views of the experts and explore the future of payment and settlement systems together. To this end, the Bank of Japan will continue to host the Future of Payments Forum in the future. Moreover, the Bank of Japan has just established a research team on CBDC within the Payment and Settlement Systems Department and will conduct further study on various issues through information exchange and discussions with the experts and relevant institutions in Japan, and other central banks. Thank you very much for your kind attention. 4/4 BIS central bankers' speeches
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