Opening Speechby Toshihiko Fukui,Governor of the Bank of Japan

I. Introduction
Good morning, ladies and gentlemen. It is my great honor to address the 14th
international conference hosted by the Institute for Monetary and Economic Studies.
On behalf of my colleagues at the Bank of Japan, I welcome all the distinguishedguests from central banks, international organizations, and academia. The theme ofthis year’s conference is “Growth, Integration, and Monetary Policy in East Asia.”

II. East Asia’s Growing Integration into the Global Economy
Over the past decades, East Asia has been one of the most rapidly growing regions in
the world economy. Although the region suffered from a temporary setback owing to
the financial crisis of the late 1990s, it has exhibited an impressive economic recovery.
The average annual growth rate of East Asian emerging economies since 2000 reached
7 percent, substantially exceeding that of industrialized economies.1 Since the crisis,
there has been a considerable improvement in economic fundamentals in the region.
Large stocks of foreign exchange reserves have accumulated, balance sheets of both thecorporate and banking sectors have improved, and structural reforms in various areas
have proceeded, all of which have contributed to making East Asia more resilient toexternal shocks. It is highly likely that East Asia will continue to play a major part in
the sustained growth of the world economy.
East Asia’s high growth has been accompanied by its deepening economic integration with the world. The integration is taking place at both the inter-regional
and intra-regional levels. It is reported that Asia’s share of world trade more thandoubled during the past three decades. Intra-regional trade in East Asia also increased
considerably. The share of East Asia’s intra-regional trade is comparable with theNAFTA, although it is slightly lower than that of the EU. The increasing trade is areflection of developments in the supply chain wherein each country specializes in
the optimal parts of the global production network based on its resource endowment
and comparative advantages.
Meanwhile, it is notable that the rapid emergence of China is adding further
momentum to the growth dynamism of the world economy in various ways. First,
1. “East Asia” and “East Asian emerging economies” denote the People’s Republic of China, Hong Kong, Korea,Singapore, Taiwan, Indonesia, Malaysia, the Philippines, and Thailand.
MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007
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9China’s buoyant domestic demand provides more business opportunities for the rest ofthe world. China’s role in the world economy has gone beyond a mere production base.
It is increasingly a source of final demand as well. Second, China’s integration into theglobal economy is promoting transformation of trade, investment, and production
patterns of other economies. Previously, China maintained its comparative advantages
mainly in production of goods and services that were intensive in the use of unskilledlabor. In recent years, however, it has attracted sizable foreign direct investment fromdeveloped countries and thereby strengthened its competitiveness in production ofcapital-intensive or knowledge-intensive goods and services. Such changes on the partof China have affected comparative advantages of other East Asian economies as welland required them to reallocate domestic resources accordingly.
The efficient reallocation of resources could, in principle, lead to higher growth of
the region as a whole. At the same time, however, the adjustment process sometimes
entails certain costs. If domestic markets and institutions are not flexible enough tofacilitate reallocation of labor and financial resources from unproductive sectors to
productive sectors smoothly, the cost might appear in the form of stagnant growthand unemployment. In this regard, it is of utmost importance for policymakers tocontinuously pursue reforms to ensure that their domestic systems remain responsiveto structural changes in the economy.
On the financial front, East Asia’s integration with the international financial
system has also advanced steadily in recent years. The integration brings benefits
to the economies in the region. With more funding options available, borrowers in
the region can raise funds on more favorable terms. With more global investment
options available, investors can improve the risk profile of their portfolio throughdiversification. However, as financial integration deepens and international capital
flows become more active, negative shocks originating from one country or region
are easily transmitted to another country or region. Such transmission of shocks
is not only from developed economies to emerging economies, but also vice versa.
Asset prices, in particular, stock prices, are closely correlated both globally andregionally. It should be noted that, in such circumstances, asset prices tend to overshoot economic fundamentals from time to time, causing excessive volatility, which
could in turn negatively affect the developments in the real economy.

III. Issues for Discussion at the Conference
Whereas East Asia’s integration could bring substantial benefits to both the global
and regional economies, possible side effects should be monitored carefully. It will bea challenge to reap maximum benefits from deepening economic and financial integration while minimizing costs that could possibly arise from such integration. Keeping
these broad viewpoints in mind, let me raise several questions that I hope are discussed
at the conference.
First, what are the implications of East Asia’s growing economic and financial
integration on the global business cycle and price movements? The mechanisms
through which integration affects various economic variables are complicated. Among

10 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Opening Speechthese, the relationship between global economic integration and the inflation process
is of particular interest to central bankers. Integration of emerging economies including East Asian economies appears to have exerted downward pressure on wages andprices through intensified competition among firms. Whether this trend will continue
into the future will have important bearings on the conduct of monetary policy.
Second, what issues are raised for central banks of industrialized economies andEast Asian emerging economies by growing external imbalances? It has been argued
that global economic and financial integration has contributed to making large
current account imbalances more sustainable. East Asia has been a beneficiary of a
substantial amount of private capital flows from developed economies, and at thesame time, an exporter of an even greater amount of capital in the form of foreignreserves. This is not consistent with the prediction of traditional economic theory
that capital flows from developed economies to emerging economies where themarginal productivity of capital is higher. A question naturally arises as to whether
the phenomenon has been driven by the fundamental misallocation of global savings
and investment. In any case, disorderly unwinding of the imbalances and accompanying capital flows would have detrimental impacts on global financial stability.
It is critical for us to carefully examine the factors underlying the imbalances and thedesirable policy for both surplus and deficit economies.
Third, what kind of monetary and exchange rate regimes are appropriate for
East Asian emerging economies to pursue sustained economic growth under pricestability? In the world of highly open capital accounts, the effectiveness of monetary
policy depends on the exchange rate regimes in place. After the crisis, there has beena tendency in emerging economies to abandon exchange rates as a nominal anchor.
As a matter of fact, a growing number of economies have moved away from pegged
exchange rate regimes toward relatively more flexible exchange rate regimes. So far,it seems that the benign international market environment for emerging economies
in recent years has made such a transition more or less smooth. Nevertheless, theextent to which exchange rate fluctuation should be tolerated remains a challenging
question. Looking ahead, the appropriate policy regimes could change over time. It is
important for central banks to review the appropriateness of the policy regimes inlight of the changes in their economic and financial structure and the state of theinternational financial system.

IV. Conclusion
To conclude, East Asia has been in the process of dynamic transformation. We are stilla long way from fully understanding the policy implications of East Asia’s integration
into the global economy. I am looking forward to learning from both prominent
scholars and central bankers their analyses and perspectives on the issues. I would bedelighted if all of you could take away some insights from the discussion. Thank you.

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