Seiji Adachi: Economic activity, prices, and monetary policy in Japan
Central bank: boj | Type: speech | Date: 2021-06-02

Bank

of

Japan J u n e 2 ,

2 0 2 1

## Economic Activity, Prices, and Monetary Policy in JapanSpeech at a Meeting with Local Leaders in Shizuoka (via webcast)

## ADACHI SeijiMember of the Policy Board(English translation based on the Japanese original)

## I.

Recent Developments in Economic Activity at Home and Abroad

## A.

Developments regarding the Novel Coronavirus (COVID-19)I would like to begin my speech by talking about developments regarding COVID-19.The outbreak of COVID-19 was first identified in China in January 2020, spreading to Europe from late February, and ultimately worldwide.

The number of confirmed new cases continued to increase with large fluctuations across countries and regions.

Since the beginning of 2021, however, developments in such figures appear to have become somewhat polarized.

That is, in countries where vaccinations are steadily progressing, such as the United States, the United Kingdom, and Israel, the number of cases peaked out and has turned toward a downtrend; on the other hand, in emerging economies, which are falling behind in vaccinations, the number of cases has remained at a high level, partly affected by new variants (Chart 1).In Japan, as the number of cases has been increasing again since early spring 2021, mainly in major metropolitan areas, the government declared a state of emergency for the third time.

## B.

Overseas EconomiesWith a view to suppressing the spread of COVID-19, many countries implemented measures to constrain economic activity around spring 2020 by imposing restrictions on going outside and

on

people's

movement.

Therefore,

the

real

GDP

growth

rates

worldwide

registered substantial declines for the April-June quarter that year.Nevertheless, partly because the characteristics of COVID-19 came to light to a certain extent over time, there were no across-the-board restrictions on economic activity in subsequent waves of COVID-19, and business conditions have started to improve on a global basis (Chart 2).

With regard to the manufacturing industry, world industrial production and the world trade volume

already

exceeded

the

pre-pandemic

levels

and

have

been

on

an

expanding

trend (Chart 3).

This trend applies not only to advanced economies but also emerging economies, where COVID-19 has been spreading.

In that sense, it can be said that the impact of the spread of COVID-19 is particularly notable in the face-to-face services industry.

## C.

Japan's EconomyTurning to Japan, the economy has been on a recovery trend, led mainly by external demand, on the back of rapid economic recovery, particularly in the United States and China.

This trend is characterized by increases in demand in the machinery industry, where Japanese firms have

a

competitive

advantage,

and

the

IT

sector,

both

reflecting

the

growing

momentum toward a global expansion in business fixed investment.

Looking at Japan's exports by type of goods, it can be confirmed that those of IT-related goods and capital goods have increased clearly of late (Chart 4).That

said,

it

is

not

only

the

manufacturing

industry

that

has

seen

an

improving

trend

in business

conditions.

Among

domestic

demand-oriented

firms

in

the

nonmanufacturing industry,

business

conditions

of

retailers,

which

provide

goods,

have

been

generally

firm despite temporary store closures and other restrictions, supported by stay-at-home consumption by households that have lost opportunities for going out due to the spread of COVID-19.

Some retailers have discovered the business opportunity of expanding online sales channels and started to make active investment in e-commerce, which is one of the factors underpinning business fixed investment in Japan.

Furthermore, even in the face-toface services industry, which has been placed in a severe situation during the pandemic, some firms

that

are

motivated

to

provide

high-end

and

high

value-added

services

have

yielded added value by implementing thorough infection control and captured growing demand from customers.As just explained, the impact of the spread of COVID-19 varies significantly depending on business attributes, and the pace of recovery differs as well.

This situation is also observed in other major economies.

## D.

Policy EffectsSince

the

outbreak

of

COVID-19,

the

government

and

the

Bank

have

been

working

in coordination and implementing various measures to underpin Japan's economy.

As a result of these

measures,

a

tightening

of

firms'

funding

conditions

has

been

averted

and

the environment

for

external

funding,

such

as

bank

borrowing

and

the

issuance

of

CP

and corporate bonds, has remained accommodative.

The numbers of corporate bankruptcies anddiscontinued businesses have also been at extremely low levels.

At the press conference at the end of March 2020 upon my appointment as a Member of the Policy Board, I noted that the first priority was to support corporate financing and that the Bank should actively provide liquidity.

Thereafter, at the Monetary Policy Meetings (MPMs) held in April and May 2020, the

Bank

swiftly

set

out

a

strengthening

of

liquidity

provision

measures

with

a

view

to supporting

corporate

financing.

Such

policy

responses,

coupled

with

the

government's economic measures, have been effective in preventing a further pandemic-driven deterioration of Japan's economy.

## II.

Outlook for Economic Activity at Home and Abroad

## A.

Uncertainties regarding the OutlookAs I described earlier, economic activity at home and abroad has continued on an improving trend so far.

That said, I think there remain extremely high uncertainties regarding the outlook.

I would like to point to the following three uncertainties.The

first

concerns

the

pace

of

progress

with

vaccinations

in

Japan.

Unless

considerable progress

is

made

and

the

overall

society

succeeds

in

achieving

herd

immunity,

there

is concern that economic activity may be constrained in the face-to-face services industry, such as eating and drinking as well as accommodations, every time COVID-19 cases resurge, and that this could delay the industry's recovery.

Repeating this situation will make it difficult to envisage sustainable improvement in consumer sentiment.

I will closely monitor developments in the pace of vaccination progress in Japan, as it is an important factor when envisioning sustainable economic recovery.In relation to this, services consumption in the United States, which almost inevitably was suppressed from last year, has started to recover rapidly, mainly supported by an acceleration in vaccinations and large-scale economic measures (Chart 5).

Looking back, I find that such quick recovery in consumption is similar to the rapid expansion seen in the country at the time of the transitional period after World War II.

Back then, demand for consumption of durable goods and services, which had been restrained during the war, was unleashed upon its end.

As for the current COVID-19 crisis, attention is warranted on whether a decline in the number of confirmed cases resulting from vaccinations would unleash the suppresseddemand.

As I will elaborate on later, I personally believe that, if consumption expands rapidly and

significantly

in

Japan

as

in

the

United

States

post-war,

this

may

provide

a

great opportunity to resolve Japan's protracted deflation.The second uncertainty involves developments in global financial markets, particularly the U.S.

stock

market.

In

global

financial

markets,

market

sentiment

has

continued

on

an improving

trend

and

prices

of

risk

assets

such

as

stocks

have

risen,

due

to

heightened expectations

for

a

recovery

in

the

global

economy,

mainly

on

the

back

of

progress

with vaccinations

and

the

additional

economic

measures

taken

in

some

advanced

economies (Chart 6).

As I mentioned earlier, U.S. consumption has started to recover rapidly.

However, it is necessary to bear in mind the potential impact on the U.S. stock market of a shift in the flow of funds from one that likely had been into that market to one into markets for goods and services.

This is because there is a risk that such market developments may affect the U.S. real economy and in turn Japan's external demand, which has been underpinning its economic recovery.The third uncertainty concerns "geoeconomical" risks.

Here, I would like to use the term "geoeconomical" rather than "geopolitical." My view is that, in recent international affairs, diplomatic

and

security

policies

and

economic

policies

tend

to

be

discussed

in

a

more integrated manner.

In general, geopolitics take into account diplomatic and security policies, whereas geoeconomics equally incorporate economic policies.

Taking U.S.-China relations as

an

example,

while

various

discussions

may

be

held

on

such

topics

as

transferring technology and capital across borders, attention

is

warranted

on

how

the

course

of

these discussions will potentially affect corporate activities and trade in Japan, among other factors.As

illustrated,

I

believe

that

uncertainties

surrounding

domestic

and

overseas

economies remain extremely high and it is necessary to assess the outlook without preconception.

## B.

Policy Responses Going ForwardIn the face of such uncertainties, I consider one of the Bank's policy challenges for the time being to be the treatment of the Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19), for which the duration at present is until end-September2021.

The environment surrounding corporate financing has generally remained stable so far, including the situation regarding bankruptcies of firms, and industries strongly affected by the spread of COVID-19 appear to be becoming limited.

In fact, the issue with corporate financing is shifting from liquidity to solvency.

Accordingly, the funding needs of some firms have begun to shift from borrowing to securing capital funds.

These developments suggest that the environment surrounding the Special Program is changing.At

the

same

time,

it

is

difficult

to

envisage

a

clear

recovery

in

face-to-face

services consumption until herd immunity is achieved through widespread vaccinations.

Thus, as long as COVID-19 cases resurge repeatedly, we cannot rule out the possibility of firms having funding difficulties.Taking into account such environmental changes surrounding corporate financing, the Bank needs

to

deepen

discussions

on

the

treatment

of

the

Special

Program

from

this

October onward by carefully monitoring future developments in corporate financing.

## III.

In View of the Post-COVID-19 Era and toward Achievement of the 2 Percent Price Stability Target

## A.

Importance of Achieving the 2 Percent Price Stability TargetIn

March

2021, the

Bank

conducted

an assessment

of

the

positive

and

side effects

of

its monetary

policy

to

date

for

the

purpose

of

conducting

further

effective

and

sustainable monetary easing (Chart 7).

While the assessment was detailed and multifaceted, what I found particularly noteworthy was how its findings reconfirmed that prices in Japan are strongly influenced by the adaptive formation of inflation expectations -- in other words, people's perception

of

prices

shaped

in

accordance

with

such

factors

as

historical

trends

and observations.

I have come to realize that, in achieving the 2 percent price stability target, a change must somehow be induced in this deeply entrenched perception of prices.Of course, individual firms and households differ in their views on prices.

As for the price stability target of 2 percent that the Bank aims to achieve, I would not be surprised if a certain number of firms and households had the following concern.

When the price stability target is achieved, would this not affect people's daily lives in the eyes of households?

Or, from theperspective of firms, would this not result in a worsening of profitability through an increase in costs?Looking back at the so-called deflationary period in the past, many firms, in efforts to survive, sought to reduce labor costs by means of, for example, reviewing employment forms.

This resulted in a vicious cycle: the income situation of households deteriorated due to a decrease in wages, restrained consumption led to a decline in firms' sales, and firms had no choice but to adjust their employment.

The serious appreciation of the yen under deflation also caused prolonged deflation.The bold and large-scale monetary easing conducted by the Bank since 2013 successfully put an end to the prolonged deflationary trend from which Japan's economy had suffered.

In this process, the employment situation recovered and firms, as they saw improvement in their earnings projections, came to sense labor shortage.

It is my understanding that Japan's labor shortage had already been widely acknowledged as a medium- to long-term challenge facing its economy prior to 2013.

What, then, led the wider public to take up the issue from 2013 onward?

I believe this was partly due to the fact that an increasing number of firms sought to continue

with

or

expand

their

businesses

into

the

future

as

the

prospect

of

overcoming deflation

came

into

sight.

Until

then,

the

issue

of

labor

shortage,

which

stemmed

from

a declining

and

aging

population,

may

have

been

obscured

because

firms

had

to

consider downsizing on the assumption that deflation would continue.As such, the deflationary environment surrounding Japan's economy has eased considerably, but there is still room for further improvement.

Needless to say, if we take a look at Japan's employment situation, those who have the willingness to work but are unable to participate in the labor market still exist, as do many small and medium-sized firms, particularly local firms, facing severe business conditions.In other words, I believe that, in Japan, there remains economic slack that should be fully exploited, and achieving the 2 percent price stability target would support efforts to absorb this in terms of monetary policy.

Achievement of the target is not intended to solely raise prices.

Rather, let me clarify that achieving the optimal price level that would bring about themost favorable economic environment would significantly enhance our standard of living.

I would like to stress once again that the 2 percent price stability target is a key policy objective that the Bank must steadfastly work to achieve.

## B.

Toward Achievement of the 2 Percent Price Stability TargetThe

findings

of

the

Bank's

latest

assessment

confirmed

that

prices

in

Japan

are

strongly influenced by the adaptive formation of inflation expectations.

To achieve the 2 percent price stability target, the Bank needs to change the deeply entrenched perception of prices.

In doing so, it would be crucial to raise the inflation expectations of firms and households in tandem with a sustained increase in the expected growth rate.

This implies that we must anticipate a long battle toward achieving the 2 percent price stability target.How the Bank should take part in boosting the expected growth rate is a quite complex issue.

At present, there is no doubt that Japan's expected growth rate is low (Chart 8).

In my view, the

role

the

Bank

can

play

in

raising

growth

expectations

for

Japan's

economy

is

to persistently continue with the current monetary easing and thereby, for example, encourage improvement in corporate productivity, such as through expanded business fixed investment.

Moreover, if we are bracing for a long battle, it is possible that some kind of external shock will exert significant downward pressure on Japan's economy in the meantime.

If this happens, the Bank must not hesitate to take additional easing measures.

It reviewed its policy measures at the March 2021 MPM to enable such sustainable and nimble policy conduct, in light of the findings of its assessment (Chart 9).

## C.

Post-COVID-19 Era and Achievement of the Price Stability TargetI believe the Bank can achieve the 2 percent price stability target by persistently continuing with monetary easing under the revised policy measures.

I am also paying close attention to the possibility that behavioral changes within Japanese firms and households drawn from the experience of the pandemic will alter the existing price perception.

Although COVID-19 will subside eventually, it is difficult to imagine the virus being eradicated.

While vaccinations are expected to have a reasonable effect, the face-to-face services industry in particular, such as eating and drinking as well as accommodations, may need to continue to bear significant costs related

to

infection

control,

considering

that

living

with

COVID-19

is

unavoidable.

Inaddition, given the increasingly aging population in Japan, one possibility is that consumption of

high

value-added

goods

and

services,

even

at

high

prices,

will

drive

overall

private consumption.

In that case, wages of workers capable of providing such high value-added goods and services will naturally be set higher.

With these factors in mind, I have come to think that the post-COVID-19 phase may be an opportunity for the services industry to raise the prices of their services while improving their quality.

As Japan's past deflationary phase is characterized by the fact that there were almost no price rises in the domestic demandoriented services industry, the post-COVID-19 era may afford a prime opportunity to achieve the 2 percent price stability target.Of course, this view entails high uncertainties.

How things actually play out will depend on firms' business strategies based on their prospects for the post-COVID-19 era.

I sometimes get feedback that firms in Japan may find it difficult to raise sales prices because of concern that a vague uneasiness about the future might hinder improvement in consumer sentiment.

The Bank will continue to support Japan's economy in fostering an economic environment where some degree of occasional price rises is socially tolerated.There are also other factors suggesting that prices may rise more than expected.

One example is firms' environmental, social, and governance (ESG) initiatives.

In particular, I am following the Impact-Weighted Accounts Initiative headed up by Professor George Serafeim of Harvard Business School in the United States. 1 I believe this project represents vital research that will foster the spread of ESG investment amid heightening global awareness of climate change risks.

One facet of this research is the attempt to incorporate carbon dioxide emissions, a cause

of

global

warming,

into

financial

accounts

as

a

corporate

cost.

What

I

am

keenly interested in is the concept that generous worker compensation increases the well-being of society, which is the underlying value of economic activity.

Based on this concept, the project attempts to reflect wages in financial accounts, not as a cost to firms but as added value produced by them.

If these attempts create a new trend in corporate accounting, higher wages may in turn contribute to an increase in prices.1 The

Impact-Weighted

Accounts

Initiative

attempts

to

reflect

in

the

financial

statements

the environmental and social impact of firms' activities in terms of numerical value so that firms and investors, in their decision-making, can take that into account, and not just the financial impact.

## D.

Learning from HistoryAs I noted earlier, we need to brace for a long battle to achieve the 2 percent price stability target.

While the Bank has been conducting bold monetary easing, some may say that it is better to review monetary policy at an early stage once there are solid prospects of postCOVID-19 economic normalization in Japan.

However, one lesson taken from the Great Depression

and

other

economic

crises

is

that

a

hasty

revision

of

monetary

policy

would actually undermine a nascent economic recovery and end up triggering a new crisis.

As a policymaker, I take this lesson to heart.On this score, the Bank, under the current policy framework, commits to continued expansion of the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) excluding fresh food exceeds 2 percent and stays above this target level in a stable manner.

The intention here is to enhance the credibility of achieving the price stability target of 2 percent through an extremely strong commitment, in that the Bank promises to continue with

monetary

easing

based

on

observed

CPI

inflation

rather

than

the

outlook

for

CPI inflation.Thank you.

## Economic Activity, Prices, and Monetary Policy in JapanSpeech at a Meeting with Local Leaders in Shizuoka (via webcast)June 2, 2021 ADACHI Seiji Member of the Policy Board Bank of JapanChart 1

## COVID-19

## Confirmed New Cases of COVID-19

## Share of Vaccinated People%Notes: 1.

In the left-hand chart, figures for the United States, Taiwan, and Hong Kong are from the Centers for Disease Control and Prevention (CDC), the Taiwan Ministry of Health and Welfare, and the Hong Kong Centre for Health Protection, Department of Health, respectively.

All other figures are from the World Health Organization (WHO).

Figures for Europe are the sum of figures for the European Union and the United Kingdom.

Figures for Latin America are the sum of figures for the major economies in the region.

Figures for other emerging economies are the sum of figures for South Africa, Russia, Turkey, and the major economies in the NIEs and ASEAN and the Middle East.

Figures show 7-day backward moving averages.2.

The right-hand chart shows the share of the total population who received at least one dose of the COVID-19 vaccine.

Figures for Latin America and the NIEs and ASEAN are for the major economies in the respective regions.

In the case of missing figures, the latest figure available prior to the relevant date is used.

## Global Purchasing Managers' Index (PMI)Note: 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: IHS Markit (© and database right IHS Markit Ltd 2021.

All rights reserved.).World Industrial Production and World Trade Volume Chart 3Note: Figures for the world trade volume are those for real imports.

Source: CPB Netherlands Bureau for Economic Policy Analysis.

## Real Exports by Type of GoodsNotes: 1.

Based on staff calculations.

Figures in angular brackets show the share of each type of goods in Japan's total exports in 2020.2.

Figures for 2021/Q2 are those for April.Sources: Bank of Japan; Ministry of Finance.

## U.S. Private ConsumptionNotes: 1.

Figures for retail sales exclude those of motor vehicle and parts dealers, gasoline service stations, building material stores, and restaurants.

Figures for restaurant sales are those for retail sales of restaurants.

Figures for consumer confidence refer to the University of Michigan's consumer sentiment index.2.

The latest figures for sales and consumer confidence are as of April and May 2021, respectively.Source: Haver.

## Chart 5

## Selected Stock PricesNote: Figures for emerging markets are based on the MSCI Emerging Markets Index calculated in the local currencies.

Source: Bloomberg.Chart 7

## Assessment for Further Effective and Sustainable Monetary Easing

## QQE with Yield Curve Control has had positive effects in line with the intended mechanism-  Economic activity, employment, and profits have improved, and the economy is no longer in deflation.

Positive moves toward addressing the medium- to long-term challenges facing Japan's economy have been observed.-  That said, changing people's mindset and behavior based on the assumption that prices will not increase easily , which have become deeply entrenched because of the experience of prolonged deflation, will take time.- ⇒ The Bank judges it appropriate to continue with QQE with Yield Curve Control with a view to achieving the price stability target of 2 percent.

## Yield Curve Control-  Yield curve control has been effective in pushing up economic activity and prices through a decline in funding costs and favorable conditions in financial and capital markets.-  Yield fluctuations within a certain range have positive effects on the functioning of the JGB market without impairing the effects of monetary easing.-  An excessive decline in super-long-term yields could have a negative impact on economic activity by, for example, undermining people's sentiment.

## ETF and J-REIT Purchases-  Large-scale purchases during times of heightened market instability are effective.

## Inflation-Overshooting Commitment-  The "makeup strategy," which this commitment is implementing, is appropriate.

## Effects on the Functioning of Financial Intermediation-  Financial institutions' core profitability has declined due to prolonged low interest rates and structural factors.-  It is necessary to pay attention to both overheating and pullback risks to the financial system.

## Expected Growth RateNote: Based on the Annual Survey of Corporate Behavior .

Figures show the result for listed firms in a particular survey year for the next three years ahead.

Source: Cabinet Office.

## Further Effective and Sustainable Monetary Easing: Policy Actions Chart 9To achieve the price stability target of 2 percent, the Bank will (1) continue with monetary easing in a sustainable manner and (2) make nimble and effective responses without hesitationto counter changes in the situation.

## Conduct of Yield Curve Control Establishment of the Interest Scheme to Promote Lending (see the box on the right)Clarification of the range of fluctuations in long-term interest ratesExpect long-term interest rates to move within the range of around ± 0.25% from the target levelIntroduction of "fixed-rate purchase operations for consecutive days"Strengthen the fixed-rate purchase operations, which stop a significant rise in interest rates

## Conduct for the time beingPrioritize stabilizing the entire yield curve at a low level under the continuing impact of COVID-19 in particular

## ETF and J-REIT PurchasesPurchase as necessary with upper limits * on the annual paces of increase, and maintain these limits even after COVID-19 subsides* ETFs ： about 12 tril. yen   J-REITs ： about 180 bil. yenPurchase only ETFs tracking the Tokyo Stock Price Index (TOPIX)Financial System and Bank Examination Dept. staff will make a briefing at the MPMs when the Outlook Report is decided (four times a year). Apply incentives (linked to the short-term policy interest rate) to financial institutions' current account balances, corresponding to the amount outstanding of funds provided through fund-provisioning measures to promote lending- MiƟgate the impact on financial insƟtuƟons' profits at the Ɵme of rate cuts depending on the amount of lending- The applied interest rates and the eligible fund-provisioning measures for each category will be changed as necessary at MPMs depending on the situation. |

| Applied interest rate

| Eligible fund-provisioning measure

||--------------|------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|| Category I

| 0.2% Higher than the rate for Category II

| • Special Operations in Response to COVID-19 , when funds are provided against loans made by financial institutions on their own

|| Category II

| 0.1% Absolute value of the short-term policy interest rate | • Special Operations in Response to COVID-19 , when funds are provided against loans other than those for Category I and against private debt pledged as collateral || Category III | 0% Lower than the rate for Category II

| • Loan Support Program • Operation to Support Financial Institutions in Disaster Areas

|⇒Enable the Bank to cut short- and long-term interest rates more nimbly while considering the impact on the functioning of financial intermediationIn addition, adjustments to the Complementary Deposit Facility will be made to narrow the gap between the actual Policy-Rate Balances and the "hypothetical" Policy-Rate Balances.