Junko Nakagawa: Economic activity, prices, and monetary policy in Japan
Central bank: boj | Type: speech | Date: 2023-03-01

Bank

of

Japan March

1,

2 0 2 3

## Economic Activity, Prices, and Monetary Policy in JapanSpeech at a Meeting with Local Leaders in Fukushima

## NAKAGAWA JunkoMember of the Policy Board

## I.

Current Situation of Economic Activity and Prices

## A.

Economic Developments AbroadI would like to begin my speech by talking about the current situation of overseas economies.The pace of recovery in overseas economies has slowed as the effects of rapid policy interest rate hikes that have been carried out by central banks since 2022 have gradually started to weigh on the real economy.

In its January 2023 World Economic Outlook (WEO) Update , the International Monetary Fund (IMF) projected that the global economic growth rate would slow from an estimated 3.4 percent in 2022 to 2.9 percent in 2023.

An indicator measuring business

sentiment

has

stayed

below

50,

the

break-even

point

between

improvement

and deterioration (Chart 1).Let me take a look at developments in overseas economies by major region.

In the United States,

private

consumption

and

the

employment

situation

have

been

firm.

However,

a marked impact of policy interest rate hikes has been seen in housing investment, as evidenced by, for example, a decline in the number of housing starts.

Production has remained more or less flat.

In Europe, as the resumption of economic activity from the COVID-19 pandemic has

run

its

course,

signs

of

slowdowns

are

becoming

clearer

due

to

strong

inflationary pressure stemming from the continued effects of the situation in Ukraine.

In China, although private consumption and production have been weak, due in part to the surge in the number of

COVID-19 cases at

the

end

of

2022,

there

have

been

moves

toward

normalization

of economic activity recently.

Albeit with variation across countries and regions, as outlined earlier, signs of slowdowns in overseas economies are becoming clearer on the whole.

## B.

Economic Developments in JapanTurning to the current situation of Japan's economy, the overall picture shows that it has picked up, particularly in terms of business fixed investment and private consumption, as the resumption of economic activity has progressed while public health has been protected from COVID-19.

I

would

like

to

describe

Japan's

economic

situation

from

two

aspects:

the corporate sector and the household sector.

## 1.

Corporate sectorLet me start with the corporate sector.Corporate

profits

have

been

at

high

levels

on

the

whole,

mainly

reflecting

the

easing

of supply-side

constraints,

although

current

profits

for

the

July-September

quarter

of

2022 declined

slightly

from

the

previous

quarter

(Chart

2).

Business

sentiment

is

more

or

less unchanged on the whole.

The Bank of Japan's December 2022 Tankan (Short-Term Economic Survey of Enterprises in Japan) showed that sentiment for nonmanufacturing has improved, mainly

for

private

consumption-related

industries

such

as

eating

and

drinking

services, accommodations, and retail.

However, sentiment for manufacturing has been more or less flat due to the effects of high raw material costs and production adjustments for IT-related goods.With

corporate

profits

being

at

high

levels,

business

fixed

investment

has

continued

to increase moderately.

There is a view that this increase has been driven mainly by digital- and labor saving-related investments, investment intended for construction of logistics facilities on the back of an expansion in e-commerce, and investment related to urban redevelopment projects.Production and exports have also continued on their uptrend, albeit with fluctuations, with the waning of supply-side constraints (Chart 3).

Looking at industrial production by industry, that of transport equipment has returned to a moderate uptrend, as the effects of the global semiconductor

shortage

have

gradually

eased.

Production

of

"electrical

machinery,

and information and communication electronics equipment" has increased for on-board equipment for motor vehicles, as has production of items used for personal computers and peripheral devices, partly due to renewal demand associated with the end of support for some operating systems.

On the other hand, electronic parts and devices have been under stronger inventory

adjustment

pressure,

particularly

on

memory

for

smartphones

and

personal computers.

With respect to exports, those to advanced economies have increased as a trend, mainly for automobile-related and capital goods.

As for exports to emerging economies, on the other hand, those to China as well as the NIEs and the ASEAN economies have been somewhat weak for intermediate and IT-related goods.

## 2.

Household sectorNext, I would like to explain developments in the household sector from the aspects of private consumption and the employment and income situation.Private consumption has increased moderately, as the resumption of consumption activities has progressed while public health has been protected (Chart 4).

Breaking down household consumption by services and goods, services consumption as a whole has increased with a pick-up in travel and dining-out.

Specifically, although overseas travel has remained at a low level, domestic travel has increased not only for short but also long distances, partly due to the positive contribution of the government's domestic travel discount program.

Dining-out has shown signs of a pick-up from the plunge seen during the pandemic, albeit mainly in terms of small groups (Chart 5).

As for goods consumption, that of durable goods has seen the following developments: while sales of new cars have increased on the back of a pick-up in production reflecting the waning of supply-side constraints, sales of household electrical appliances have declined for seasonal items in particular, presumably due in part to relatively higher temperatures in November than in normal years.

When fluctuations are smoothed out, consumption of nondurable goods has increased, mainly for clothes, although the effects of high inflation have been seen for food.The employment and income situation has improved moderately on the whole.

Labor market conditions have been considerably tight, with various related indicators being at levels close to those observed prior to the pandemic and during the bubble economy of the late 1980s (Chart

6).

Under

these

circumstances,

the

number

of

regular

employees

has

increased moderately, mainly in the medical, healthcare, and welfare services industry as well as the information and communications industry, both of which have faced a severe labor shortage; the

number

of

non-regular

employees

has

also

risen

moderately,

mainly

in

the

medical, healthcare, and welfare services industry as well as the face-to-face services industry (Chart 7).

Total employee income has continued to increase in nominal terms due to moderate rises in both the number of employees and total cash earnings per employee.

## C.

Price Developments in JapanNext, I would like to talk about price developments in Japan.Let

me

first

touch

on

the

price

trend

of

goods

and

services

traded

within

the

domestic corporate sector.

Reflecting the earlier raw material cost increases, the year-on-year rate of change in the producer price index (PPI), which covers goods prices, has remained high, marking 9.5 percent for January 2023 (Chart 8).

That in the services producer price index (SPPI), which covers the price of services within the corporate sector, has also continued to see a moderate rise, although the rise has not been as steep as that of the PPI.

Looking at the price indexes that divide demand into four stages of intermediate demand from the upstream to downstream stages of supply chains, the earlier raw material cost increases have continued to be passed on to selling prices at the midstream to downstream stages.In this situation, the consumer price index (CPI) has continued to reflect a pass-through to selling prices of raw material cost increases.

Looking at the most recent data available, the year-on-year rate of change in the CPI for all items excluding fresh food was 4.2 percent for January, in reflection of rises in the price of such items as energy, food, and durable goods (Chart 9).

The pass-through of cost increases to prices has been observed for a wide range of goods and services: food, daily necessities, and durable goods for the former, and dining-out for the latter.

This holds true even when excluding the effects of (1) items with significant price fluctuations, such as energy, and (2) temporary factors, including the domestic travel discount program.In what follows, I would like to explain in detail the background to the recent price rises from the viewpoints of a change in firms' price-setting stance and the underlying trend in prices.

## 1.

Firms' price-setting stanceLet me start with firms' price-setting stance.

Firms have been increasingly passing on cost increases to selling prices.According to an analysis based on the results of the Bank's Tankan surveys, firms that had not

changed

prices

in

the

past

have

begun

to

change

course

toward

raising

prices.

The diffusion

index

(DI)

for

output

prices

suggests

that

a

significant

number

of

these

firms responded that output prices have changed to a "rise" for the first time in more than three decades (Chart 10).What lies behind the change in their price-setting stance is the significant rise in raw material costs.

Previously, amid the relatively small rise in such costs, many firms did not change prices for fear of losing their customers and barely withstood the increased costs by improving efficiency and reducing expenses.

However, even they have been obliged to decide on raising their prices, as a broad range of firms -- including competitors -- have opted for price hikes in reflection of the considerable increase in raw material costs since 2022.

## 2.

Underlying trend in pricesNext, I will explain the underlying trend in the CPI based on various indicators released by the Bank.First,

it

can

be

pointed

out

that,

as

firms'

price-setting

stance

has

changed,

prices

have increased for a broad range of items.

Of all items covered by the CPI, those for which the price has increased accounted for over 80 percent, whereas those for which the price has declined accounted for around 10 percent, both on a year-on-year basis as of January 2023 (Chart 11).

Even compared with around 2008, when the CPI rose triggered by higher import prices of crude oil and other items, price hikes have spread across a wider range of items.Let us also look at other indicators that take into consideration the price change distribution.

In terms of both the trimmed mean -calculated by excluding items that belong to the upper and lower 10 percent of the price change distribution -- and the mode -- which is the inflation rate with the highest density in the distribution -- the year-on-year rates of change in the CPI have increased to around 3 percent and around 1.5 percent, respectively (Chart 11).

However, those increases have fallen short of a 4.3 percent rise in the headline CPI.

One thing that is clear from those indicators is that, even though the pass-through of cost increases has been spreading to a wider range of items, the overall CPI has been significantly pushed up by a small group of items such as energy.

As will be touched on again later when I explain the outlook for prices, the contribution made by items that have led CPI inflation is likely to become markedly smaller as the rise in import prices subsides.

Consequently, the overall CPI inflation rate is expected to decelerate.

While using the indicators that I just explained, the Bank will continue to examine the underlying trend in prices.

## II.

Outlook for and Risks to Economic Activity and Prices

## A.

OutlookNext, I would like to turn to the outlook for Japan's economic activity and prices.Japan's economy is likely to continue recovering with the impact of COVID-19 and supplyside

constraints

waning,

although

it

is

expected

to

be

affected

by

slowdowns

in

overseas economies

and

high

commodity

prices.

From

a

medium-

to

long-term

perspective,

the economy is projected to continue growing at a pace above its potential as a virtuous cycle from income to spending intensifies gradually.As presented in the Outlook for Economic Activity and Prices (Outlook Report) decided by the Bank at the January 2023 Monetary Policy Meeting (MPM), the medians of the Policy Board members' forecasts for real GDP growth rates are 1.7 percent for FY2023 and 1.1 percent for FY2024 (Chart 12).The rate of increase in consumer prices is expected to decelerate noticeably for the time being, given that (1) the contribution from higher import prices, which have been pushing up overall inflation thus far, is likely to dissipate, due in part to a decline in commodity prices, and (2) the

government's

economic

measures

to

contain

inflation

will

take

effect.

Under

these circumstances, the medians of the Policy Board members' forecasts for the year-on-year rate of change in the CPI for all items excluding food are 1.6 percent for FY2023 and 1.8 percent for FY2024, down from the forecast of 3.0 percent for FY2022 (Chart 12).

## B.

RisksThe

outlook

for

economic

activity

and

prices

that

I

just

mentioned

entails

a

range

of uncertainties.

In what follows, I will describe the risks that I am paying particular attention to.First is developments in overseas economic activity and prices, and in global financial and capital markets.

Central banks have made rapid policy interest rate hikes since 2022 in order to combat strong inflationary pressure.

Owing in part to the effects of these rate hikes, global inflationary

pressure

has

started

to

show

signs

of

easing.

The

Bank's

baseline

scenarioassumes

that

the

pace

of

monetary

tightening

will

become

moderate

and

its

effects

on economic activity will be only relatively modest.

However, given that the rate of increase in services prices has remained high in some advanced economies, there is a risk of continued uncertainty regarding how much monetary tightening will be needed before inflation abates.

If stronger-than-expected monetary tightening will be required, this will accordingly exert a severe negative impact on economic activity.

In that case, there is a possibility that sharp price fluctuations in financial markets and capital outflows from emerging economies will amplify the negative impact, and that this will lead to overseas economies deviating downward from the Bank's baseline scenario.Second is geopolitical risks and developments in the price of commodities, including grain.

More than a year has passed since the onset of Russia's invasion of Ukraine, and the situation is becoming more prolonged.

It is difficult to predict at this point how it will evolve; however, depending on the course of this situation, overseas economies, particularly Europe, could be pushed down further.

Furthermore, the price of grain and other commodities, which has been more stable than previously, may be adversely affected.The third point that I am particularly attentive to is firms' and households' medium- to longterm growth expectations.

Recently, firms have been actively making investment with a view to

the

post-COVID-19

era,

digitalization,

and

decarbonization,

and

these

initiatives

are expected to enhance their growth potential in the long term.

On the other hand, some firms have revised their strategies regarding supply chains.

This is based on heightened concern over geopolitical risks, mainly reflecting the situation in Ukraine and the U.S.-China trade friction, and the experience of supply-side constraints caused by the pandemic.

In doing so, they have reviewed so-called friend-shoring supply chains -- an approach of establishing trade networks mainly with allies and friendly nations.

Since these actions are taken to prioritize stability even at the cost of sacrificing efficiency to some extent, they could induce upward pressure on prices.

In the event of a change in the trend of globalization, which has supported the

growth

of

the

global

economy

to

date,

future

developments

in

economic

activity

and prices

may

be

affected

through

changes

in

firms'

and

households'

medium-

to

long-term growth expectations.Lastly, I would like to point out firms' price- and wage-setting behavior as a risk that may significantly affect overall inflation.

As I mentioned earlier, firms that had not changed their selling prices before have decided to raise them in the face of steep increases in raw material costs.

If firms' inflation expectations become higher, the pass-through of cost increases could accelerate

further.

Wages

are

expected

to

rise

in

line

with

improvement

in

economic conditions.

However, uncertainty is high as to what extent wages will rise.

If the behavior and mindset based on the assumption that wages will not increase easily remain deeply entrenched, there is a risk that moves to increase wages will not strengthen as much as expected and prices will in turn be under downward pressure.

At present, large firms in particular hold a stance of increasing wages at a rate exceeding the inflation rate.

I am paying close attention to the extent to which small and medium-sized firms will follow suit.

## III.

The Bank's Monetary PolicyNext, I would like to talk about the Bank's monetary policy conduct.Since April 2013, the Bank has continued large-scale monetary easing with an unwavering commitment to achieving the price stability target of 2 percent at the earliest possible time.

However, as it turned out, it has been taking time to achieve the target.

In pursuing monetary easing over a long period, the Bank has been taking into consideration its side effects.

An example of such side effects is the squeeze on financial institutions' profits under the low interest

rate

environment, which in turn may adversely affect the functioning of financial intermediation.

Having

said

that,

the

Bank

judges

that,

currently

in

Japan,

financial institutions have sufficient capital bases and the financial intermediation function is being fulfilled smoothly.

In addition, as the liquidity and functioning of bond markets have been deteriorating, the Bank, while taking measures to contain this side effect, has continued with its monetary easing.Specifically, in March 2021, the Bank conducted an assessment of the measures taken until then

in

order

to

continue

with

monetary

easing

in

a

sustainable

manner.

The

Bank

had previously

been

conducting

yield

curve

control

in

a

way

that

kept

10-year

Japanese government bond (JGB) yields at around 0 percent; following the assessment, however, it made clear that the range of 10-year JGB yield fluctuations would be between around plusand minus 0.25 percentage points from the target level.

The Bank also decided to purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) flexibly in a prioritized manner, as the findings of the assessment suggested that large-scale purchases of these instruments were effective during times of heightened market instability.Subsequently,

at

the

December

2022

MPM,

the

Bank

decided

that,

while

significantly increasing the amount of JGB purchases, it would expand the range of 10-year JGB yield fluctuations from the target level from between around plus and minus 0.25 percentage points to between around plus and minus 0.5 percentage points.

The Bank also decided that it would make

nimble

responses

by

increasing

the

amount

of

JGB

purchases

even

more

and conducting fixed-rate purchase operations (Chart 13).These decisions were made in order to facilitate the transmission of monetary easing effects generated under the framework of yield curve control -- such as through corporate financing -- by encouraging a smoother formation of the entire yield curve.

While 10-year JGB yields had been hovering in the range of around plus and minus 0.25 percentage points from the target level, a distortion has occurred in the relative relationships between the interest rates of JGBs with 10-year maturity and those with other maturities.

A large price gap has also been observed between spot and futures markets.

Such market distortions have resulted in, for

example,

difficulty

in

the

pricing

of

corporate

bonds

at

the

time

of

issuance.

If

these market conditions persist, this could have a negative impact on firms' financing environment, such

as

issuance

conditions

for

corporate

bonds.

Therefore,

in

order

to

improve

market functioning

while

maintaining

accommodative

financial

conditions,

the

Bank

decided

to modify the conduct of yield curve control.As the range of 10-year JGB yield fluctuations has been expanded, long-term interest rates have risen accordingly.

However, in continuing with monetary easing under the framework of yield curve control going forward, the expansion has a greater merit of facilitating the transmission of monetary easing effects by improving the functioning of bond markets.As I have explained thus far, Japan's economy has started to show signs of a virtuous cycle, as evidenced by the overall high levels of corporate profits and moves to increase wages.However, it is premature to conclude that the price stability target has been achieved.

Thus, I believe that, in its conduct of monetary policy for the time being, it is necessary for the Bank to maintain monetary easing and thereby support the economy.Thank you.Source: IMF.

## Economic Activity, Prices, and Monetary Policy in JapanSpeech at a Meeting with Local Leaders in FukushimaMarch 1, 2023NAKAGAWA Junko Member of the Policy Board Bank of Japan

## Overseas Economies

## World Economic Outlook

## Global PMINote: Figures for manufacturing are the J.P.Morgan Global Manufacturing PMI.

Figures for services are the J.P.Morgan Global Services Business Activity Index.- Source: Copyright © 2023 by S&P Global Market Intelligence, a division of S&P Global Inc. All rights reserved.Chart 1

## Corporate Sector in Japan

## Corporate Profits

## Business ConditionsChart 3

## Corporate Sector in Japan

## Industrial Production

## Real ExportsNotes: 1.

Shaded areas denote recession periods.2.

The figure denoted by the circle to the right is calculated using projectionsby the Ministry of Economy, Trade and Industry for January and February 2023.Source: Ministry of Economy, Trade and Industry.2.

Based on Bank staff calculations.

The figure for 2023/Q1 is that for January.Sources: Ministry of Finance; Bank of Japan.

## Household Sector in Japan

## Private Consumption

## Consumption Activity Index (CAI, Real)s.a., CY 2015=100Sources: Bank of Japan, etc.Chart 5

## Household Sector in Japan

## Consumption of Services

## Consumption of Durable GoodsCurrent Survey of Commerce and the price index of related items in the CPI.Sources: Japan Automobile Dealers Association; Japan Light Motor Vehicle andMotorcycle Association; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications.

## Employment and Income Situation in Japan

## Various Measures of Labor Market Conditions- Notes: 1.

Figures for each measure of labor market conditions are normalized by the standard deviation from 1990 to 2019.2.

Figures for the active job openings-to-applicants ratio and the unemployment rate for 2022/Q4 are October-November averages.3.

The labor input gap and the employment rate gap are Bank staff estimates.4.

Figures for the short- and long-term unemployment rates up through 2001 are on a semiannual or annual basis.- Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Bank of Japan, etc.

## Employment and Income Situation in Japan

## Number of Employed PersonsEmployee IncomeNote: Figures for regular employees and non-regular employees prior to 2013 are based on the "detailed tabulation" in theLabour Force Survey.Source: Ministry of Internal Affairs and Communications.Notes: 1.

Q1 = March-May, Q2 = June-August, Q3 = September-November,Q4 = December-February.

The figure for 2022/Q4 is that for December.2.

Employee income = Total cash earnings ( Monthly Labour Survey ) × Number of employees ( Labour Force Survey )3.

Figures from 2016/Q1 onward are based on continuing observations following the sample revisions of the Monthly Labour Survey .3.

Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications.Chart 7

## Producer Prices

## Goods and Services Prices

## Final Demand-Intermediate Demand (FD-ID) Price Indexes (All Commodities)Source: Bank of Japan.Chart 9

## Consumer Prices

## CPI (Less Fresh Food)

## CPI (Excluding Temporary Factors)Notes: 1.

Figures for "energy" consist of those for petroleum products, electricity, as well as manufactured and piped gas charges.2.

Figures for the "effects of the consumption tax hike and free education policies" from April 2020 onward are Bank staff estimates and include the effects of measures such as free higher education introduced in April 2020.Source: Ministry of Internal Affairs and Communications.- Notes: 1. "Food" consists of "food products" and "agricultural, aquatic, and livestock products." 2. "Administered prices" excludes energy prices and consists of public services and water charges.3.

The CPI figures are Bank staff estimates and exclude the effects of the consumptiontax hike, free education policies, travel subsidy programs, and mobile phone charges.Source: Ministry of Internal Affairs and Communications.

## Consumer Prices

## Change in Firms' Price-Setting Stance

## Number of Years between the Latest and Previous Price RisesNote: Figures are for all industries and enterprises in the Tankan survey.

Figures for "firms cautious about changing output prices" are for firms that replied that their output prices were "unchanged" for at least about 95 percent of the period from 1991 to 2019.

The dotted lines represent forecasts from the September 2022 survey.Source: Ikeda, S. et al., "Firms' Recent Price-Setting Stance: Evidence from the Tankan ," Bank of Japan Review Series , no. 23-E-2 (February 2023), The panel shows the distribution of firms that responded that they had raised their output prices since the September 2021 Tankan survey in terms of the number of years that had passed until the first price rise since that survey from the previous price rise.

Firms are selected on the basis of being "cautious about changing output prices," having replied that their output prices were "unchanged" for at least about 95 percent of the period from 1991 to 2019.Source: Ikeda, S. et al., "Firms' Recent Price-Setting Stance: Evidence from the Tankan ," Bank of Japan Review Series , no. 23-E-2 (February 2023), 11

## Consumer Prices

## DI of Price Changes

## Measures of Core InflationSources: Ministry of Internal Affairs and Communications; Bank of Japan.Sources: Ministry of Internal Affairs and Communications; Bank of Japan.

## Outlook for Economic Activity and Prices (as of January 2023)y/y % chg.|

| Real GDP

| CPI (all items less fresh food)

| (Reference) CPI (all items less fresh food and energy)

||-----------------------------|---------------------|-----------------------------------|----------------------------------------------------------|| FY2022

| +1.9 to +2.0 [+1.9] | +3.0 to +3.0 [+3.0]

| +2.1 to +2.1 [+2.1]

|| Forecasts made in Oct. 2022 | +1.8 to +2.1 [+2.0] | +2.8 to +2.9 [+2.9]

| +1.8 to +1.9 [+1.8]

|| FY2023

| +1.5 to +1.9 [+1.7] | +1.6 to +1.8 [+1.6]

| +1.7 to +1.9 [+1.8]

|| Forecasts made in Oct. 2022 | +1.5 to +2.0 [+1.9] | +1.5 to +1.8 [+1.6]

| +1.5 to +1.8 [+1.6]

|| FY2024

| +0.9 to +1.3 [+1.1] | +1.8 to +1.9 [+1.8]

| +1.5 to +1.8 [+1.6]

|| Forecasts made in Oct. 2022 | +1.3 to +1.6 [+1.5] | +1.5 to +1.9 [+1.6]

| +1.5 to +1.8 [+1.6]

|Note: Figures in brackets indicate the medians of the Policy Board members' forecasts (point estimates).

Source: Bank of Japan.Chart 13

## Modification of the Conduct of Yield Curve Control (YCC)

## Impact of Increased Volatility in Overseas Markets

## Measures Decided by the Bank of Japan

## Deterioration in Japan′s bond market functioningRelative relationships among interest rates of bonds with different maturitiesArbitrage relationships between spot and futures markets

## Possibility of a negative impact on financial conditionsYields on Japanese government bonds (JGBs) are reference rates for corporate bond yields, bank lending rates, and other funding rates.JGB Yield Curve (Before the December 2022 MPM)

## Conduct of YCC

## Encourage a smoother formation of the entire yield curveSignificant increase in the amount of JGB purchases: from 7.3 trillion yen per month to about 9 trillion yen per monthExpansion of the range of 10-year JGB yield fluctuations from the target level: from between around ± 0.25% pts to between around ± 0.5% pts Nimble responses for each maturity:- Offer to purchase 10-year JGBs at 0.5% every business day through fixed-rate purchase operations- Make nimble responses for each maturity by increasing the amount of JGB purchases even more and conducting fixed-rate purchase operationsIn adjusting the amount outstanding of corporate bonds, the Bank will give due consideration to their issuance conditions.

## Facilitate the transmission of monetary easing effectsgenerated under the framework of YCC, such as through corporate financingThe Bank will aim to achieve the price stability target by enhancing the sustainability of monetary easing .