Naoki Tamura: Economic activity, prices and monetary policy in Japan
Central bank: boj | Type: speech | Date: 2024-09-12

Bank

of

JapanSeptember 12, 2024

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

## TAMURA NaokiMember of the Policy Board(English translation based on the Japanese original)

## I.

Economic Activity and Prices

## A.

Economic ActivityI

will

begin

my

speech

by

talking

about

economic

activity

in

Japan.

The

Bank

of

Japan assesses that the economy has recovered moderately on the whole, although some weakness has been seen in part.

In terms of the median of the Policy Board members' forecasts -- as presented in the July 2024 Outlook for Economic Activity and Prices (Outlook Report) -Japan's real GDP growth rate is expected to be at 0.6 percent for fiscal 2024, 1.0 percent for fiscal 2025, and 1.0 percent for fiscal 2026 (Chart 1).

While the projected growth rate for fiscal 2024 appears to be low, this reflects the impact of the negative growth registered toward the end of fiscal 2023, partly due to the effects of a suspension of production and shipments at some automakers.

That said, looking at the growth rates during the course of fiscal 2024 on a quarter-on-quarter basis suggests that Japan's economy is likely to achieve firm growth.

Thereafter, the economy is projected to keep growing at a pace above its potential growth rate, as a virtuous cycle from income to spending gradually intensifies.Chart 1: The Bank's Forecasts for Real GDPNote: Forecasts are medians of the Policy Board members' forecasts in the July 2024 Outlook Report.

Real GDP values for fiscal 2024 onward are calculated by multiplying the actual figure for fiscal 2023 by all successive projected growth rates for each year.

Sources: Cabinet Office; Bank of Japan.As

background

to

what

I

just

outlined,

let

me

now

explain

developments

in

private consumption and business fixed investment in detail.

First, private consumption as a whole has been resilient, although consumption of nondurable goods, such as food and clothes, has followed

a

decreasing

trend

in

real

terms

after

excluding

price

rises,

amid

households' defensive

attitudes

toward

spending

in

reflection

of

high

prices

(Chart

2).

As

for

these defensive attitudes, while some households have shifted toward less expensive products due to

high

prices,

many

of

them

appear

to

be

selective

in

their

consumption

--

that

is,

they actively spend on products or services that meet their values and cut back other spending.

Given that consumer behavior could have changed in response to the COVID-19 pandemic, I feel that the actual condition of private consumption may not be as weak as the statistics suggest.

With respect to income, real wages have improved recently, although for some time nominal

wage

growth

was

not

keeping

up

with

inflation.

Regarding

the

outlook,

private consumption is projected to increase moderately, underpinned by an improvement in real wages.

This is in view of the following: (1) the results of the annual spring labor-management wage negotiations this year revealed that the wage growth rate was significantly higher than the

previous

year,

including

among

small

and

medium-sized

firms

and

(2)

anecdotal information from firms -- which was gathered through the Bank's Head Office and branches -- suggests that a wider range of firms have actually been raising wages, partly because theyChart 2: Private ConsumptionNotes: 1.

In the left

panel,

figures

for

"total

real

private

consumption"

are

for

the

real

Consumption

Activity

Index

and

are

based

on

Bank

staff calculations.

The figures exclude inbound tourism consumption and include outbound tourism consumption.2.

In the right panel, figures for "nominal wages" are based on continuing observations following the sample revisions.Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Bank of Japan.are feeling the need to retain and recruit human resources to address labor shortages (Chart 3).

Moreover,

the

fact

that

a

rapid

and

one-sided

depreciation

of

the

yen

--

which

had

a negative impact on consumer sentiment -- has been corrected to a certain extent is expected to promote the moderate increase in private consumption.Chart 3: Results of the Annual Spring Labor-Management Wage NegotiationsNotes: 1.

Figures for "CPI inflation" are for all items less fresh food, excluding the effects of the consumption tax hikes.2.

Figures for "actual base pay increase" and "actual regular wage increase" from 1991 to 2014 are those published by the Central Labour Relations Commission, while those from 2015 to 2024 are figures released by the Japanese Trade Union Confederation (Rengo).

Figures are based on the wage negotiation results of labor unions for which the base pay increase is clear.Sources: Central Labour Relations Commission; Ministry of Internal Affairs and Communications; Rengo.Next, I will turn to business fixed investment.

On the back of favorable corporate profits on the whole, business fixed investment has been on a moderate increasing trend; as for the business fixed investment plans in the June 2024 Tankan (Short-Term Economic Survey of Enterprises in Japan), the reported rate for fiscal 2024 indicates a relatively high increase compared with past June Tankan surveys (Chart 4).

Under such circumstances, the remaining orders for machinery and construction have stayed on an increasing trend, as there have been some cases where firms postponed fixed investment in response to labor shortages.

Regarding the outlook, although the amount of business fixed investment could be pushed down due to these postponements, such investment is likely to follow a long-term uptrend.

This is due to firm demand for fixed investment, such as investment to address labor shortages and digitalrelated investment, as well as investments associated with the green transformation and with strengthening supply chains.Chart 4: Business Fixed InvestmentNotes: 1.

In the left panel, Tankan figures include software and R&D investments and exclude land purchasing expenses.

Figures are for all industries including financial institutions.2.

In the left panel, the figure for "private nonresidential investment" for fiscal 2024 is for 2024/Q2.3.

In the right panel, figures for "construction" are based on a survey of 50 major construction companies.Sources: Cabinet Office; Ministry of Land, Infrastructure, Transport and Tourism; Bank of Japan.

## B.

Price DevelopmentsTurning to Japan's price developments, the year-on-year rate of increase in the consumer price index (CPI) for all items excluding fresh food has been lower than before, in the range of 2.53.0

percent

recently;

that

for

all

items

excluding

fresh

food

and

energy,

for

which

prices fluctuate

significantly,

has

been at

around 2

percent (Chart

5).

The contribution of goodsChart 5: Consumer PricesSource: Ministry of Internal Affairs and Communications.prices to the rate of increase in the CPI has been declining due to the waning effects of a passthrough to consumer prices of cost increases led by the past rise in import prices.

On the other hand, the CPI has been pushed up by increases in services prices resulting from the passthrough of higher personnel expenses to consumer prices.In terms of the median of the Policy Board members' forecasts, the CPI (all items less fresh food) is projected to continue to see a year-on-year rate of increase of around 2 percent -specifically, 2.5 percent for fiscal 2024, 2.1 percent for fiscal 2025, and 1.9 percent for fiscal 2026 (Chart 6).

Although there could be an upward or downward deviation in CPI figures, price

developments

have

been

on

track

to

achieve

the

price

stability

target.

The

Bank therefore assesses that the likelihood of realizing this target has continued to rise.Chart 6: The Bank's Forecasts for the CPINotes: 1.

Figures are the CPI for all items less fresh food, excluding the effects of the consumption tax hikes.2.

The locations of , △ , and ▼ in the chart indicate figures for each Policy Board member's forecasts.

The risk balance assessed by each Policy Board member is shown by the following shapes: indicates that a member assesses "upside and downside risks as being generally balanced," △ indicates

that

a

member

assesses

"risks

are

skewed

to

the

upside,"

and ▼ indicates

that

a

member

assesses

"risks

are

skewed

to

the downside." The dotted lines show the medians of the Policy Board members' forecasts presented in the July 2024 Outlook Report.Sources: Ministry of Internal Affairs and Communications; Bank of Japan.Regarding the

outlook

for

prices,

I

am

concerned

that

risks

are

possibly

becoming

more skewed to the upside.

The first risk concerns the impact of labor shortages.

The June Tankan suggests that firms perceive labor shortages to be at substantially high levels (Chart 7).

My impression is that such shortages have become supply-side constraints, thereby causing some industries to face short supply and excess demand.

For example, the hotel industry inevitably has to limit occupancy rates while the taxi industry has been suffering from a shortage of drivers.

Furthermore, some manufacturing firms have been unable to operate at full capacity due to labor shortages.

Such a situation could cause prices to deviate upward from the baseline scenario.

Second, firms could make further progress than anticipated in passing on increased personnel expenses to selling prices, in a situation where wage growth is expected to be higher than

the

previous

year.

That

said,

firms,

especially

small

and

medium-sized

firms,

have continued to report that it has been difficult to pass on their employees' higher wages to selling prices.

Third, import prices, which had once settled down, have been on an uptrend again, partly because the yen has depreciated from the beginning of this year, despite being corrected to a certain extent recently.

In terms of passing on higher import prices, the cost pass-through rate -- which shows the extent to which firms pass on cost increases to product prices -- has been on the rise in recent years.

Thus, the uptrend in import prices could have a greater impact on the CPI than before.Chart 7: Firms' Perception of Labor and Production Capacity Shortages ( Tankan )Note: Figures are for all industries and enterprises.Source: Bank of Japan.

## II.

Conduct of Monetary Policy

## A.

July 2024 Monetary Policy Meeting (MPM)Now, I would like to turn to the Bank's conduct of monetary policy.

The Bank conducts monetary

policy

with

the

aim

of

achieving

the

price

stability

target

of

2

percent

in

a sustainable and stable manner.

Since the changes in the monetary policy framework made in March 2024, it has regarded guiding the short-term interest rate as a primary policy tool.

While the Bank intends to adjust the degree of monetary accommodation in response to an increase in the likelihood of achieving the price stability target, it decided at the July MPM to

raise the target level

of its

short-term policy interest rate by 0.15 percentage points, to around 0.25 percent (Chart 8).

## Chart 8: Change in the Guideline for Money Market Operations (July 2024)The

Bank

also

decided

on

a

plan

for

the

reduction

of

its

purchase

amount

of

Japanese government bonds (JGBs) covering the period until March 2026, aimed at enhancing the predictability

of

its

future

JGB

purchases

and

allowing

long-term

interest

rates

to

be determined by the market (Chart 9).

It should be noted, however, that the Bank has continued with

JGB

purchases

to avoid

bringing

about

discontinuous

changes

from

the

large-scale monetary easing conducted in the past, and not as an active monetary policy tool.

Going into the details of the plan, the Bank intends to gradually reduce the amount of its monthly outright purchases of JGBs -- which amounted to about 6 trillion yen up until the July 2024 MPM --Chart 9: Plan for the Reduction of the Purchase Amount of JGBs (July 2024)The concept of the plan for the reduction until March 20261.

Long-term interest rates: to be formed in financial markets in principle2.

JGB purchases: appropriate for the Bank to reduce its purchase amount of JGBs in a predictable manner, while allowing enough flexibility to support stability in the JGB marketsto about 3 trillion yen over a period of around a year and a half.

Moreover, with a view to allowing

a

certain

degree

of

flexibility

in

the

plan,

the

Bank's

decisions

included

the following: (1) it would conduct an interim assessment of the plan in June 2025 and (2) in the case of a rapid rise in long-term interest rates, would make nimble responses by, for example, increasing the amount of JGB purchases regardless of the monthly schedule of such purchases.While the amount outstanding of the Bank's JGB holdings stands close to 600 trillion yen, the amount in terms of the ratio to nominal GDP is larger by far relative to the United States and Europe (Chart 10).

Since JGBs are redeemed at maturity, reducing the purchase amount so

that

it

falls

below

the

redemption

amount

would

lower the

amount

outstanding

of

the Bank's JGB holdings.

Reducing the purchase amount at the pace decided at the July MPM, however, will require considerable time for the Bank to normalize its balance sheet -- that is, to reduce the amount outstanding of its JGB holdings to a level where further reductions are no longer necessary.

That said, it is appropriate for the Bank to set the pace of reduction at this level to proceed with the reduction without causing market disruption.

The degree of JGB market functioning has stayed low, albeit having improved, and such side effects of the Bank's large amount of JGB holdings will likely remain for some time in the process of normalizing the balance sheet (Chart 11).Chart 10: Government Bond Holdings of Major Central BanksSources: Cabinet Office; Eurostat; Federal Reserve Board; U.S. Bureau of Economic Analysis; Bank of Japan.Chart 11: Degree of Bond Market FunctioningNotes: 1.

The DIs for "degree of bond market functioning," "bid-ask spread," and "lot size" are calculated as "high" - "low," "tight" - "wide," and "large" - "small," respectively.2.

The survey from February 2018 onward includes responses from major insurance companies, asset management companies, etc., in addition to those from eligible institutions for the Bank's outright purchases and sales of JGBs.

Regarding the figures for February 2018, the reference data, which are based on responses only from eligible institutions for the Bank's outright purchases and sales of JGBs, are also indicated.Source: Bank of Japan.In

my

view,

the

Bank's

future

policy

conduct

will

be

crucial

to

normalizing

large-scale monetary easing, and there is still a long way to go.

Moreover, I have come to recognize once again the need for the Bank to carefully examine the balance between the positive effects and costs of quantitative monetary easing -- should the situation require reconsideration of such a policy measure in the future -- as well as the steps toward an exit I discussed earlier.

## B.

Conduct of Monetary Policy over the Projection PeriodLet me return to the guiding of the short-term interest rate as a primary policy tool.Underlying CPI inflation is expected to increase gradually; in the second half of the projection period

presented

in

the

July

Outlook

Report

--

which

covers

the

period

through

fiscal 2026 -- it is likely to be at a level that is generally consistent with the price stability target.

If this outlook is realized, I think it will be necessary for the Bank to raise the short-term policy interest rate to a level that is neutral to economic activity and prices -- i.e., the nominal neutral interest rate -- by the second half of the projection period that runs through fiscal 2026.

The reason is that, if the short-term interest rate stays below the level that is neutral to economic activity and prices, this will push up inflation higher than necessary.Conceptually, the neutral interest rate is the sum of the natural rate of interest -- which is the real interest rate level that is neutral to economic activity and prices -- and the expected rate of inflation.

That said, the natural rate of interest is not directly observable, and estimates of it

vary widely depending on the estimation method employed (Chart 12).

The real interest rate -- calculated as the nominal interest rate minus the expected rate of inflation -- has beenChart 12: Natural Rate of Interest and Real Interest Rate Estimates of the Natural Rate of Interest Real Interest Rate (1-Year)Notes: 1.

In the left panel, natural interest rate estimates are based on Bank staff calculations using models proposed in the respective papers.

The shaded area indicates the range of natural interest rate estimates from the minimum to the maximum.2.

In the right panel, the real interest rate is calculated as government bond yields minus the composite index of inflation expectations (Bank staff estimates).Sources: Bloomberg; Cabinet Office; Consensus Economics Inc., Consensus Forecasts ; Ministry of Finance; Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; QUICK, QUICK Monthly Market Survey ; Bank of Japan.clearly negative, falling below all estimates of the natural rate of interest.

This implies that the

current

short-term

interest

rate

level

provides

accommodative

financial

conditions;

in other words, it is at a level that will push up economic activity and prices.My sense is that the neutral interest rate would be at least around 1 percent.

Therefore, I think it is necessary for the Bank to raise the short-term interest rate to at least that level by the second half of the projection period that runs through fiscal 2026 to contain upside risks to prices and achieve the price stability target in a sustainable and stable manner.However,

how

economic

agents

in

Japan,

which

has

long

experienced

a

state

without meaningful interest

rates,

react

to

interest

rates

is

an

issue

that

warrants

careful

attention without any preconceptions.

Thus, bearing in mind that the short-term interest rate should be at the 1 percent level by the second half of the projection period that runs through fiscal 2026, I think the Bank needs to gradually raise this rate in response to the increase in the likelihood of

achieving

the

price

stability

target.

While

doing

so,

it

also

needs

to

determine

the appropriate level of the short-term interest rate by paying attention to how the economy and prices respond to the rate hikes.Stock prices in Japan and foreign exchange rates saw large fluctuations at the beginning of August.

While this was likely due to a depreciation of the U.S. dollar and a fall in stock prices on a global scale, triggered by concerns over a slowdown in the U.S. economy reflecting weak economic indicators, some have associated the fluctuations with the Bank's monetary policy.

Some have argued that the policy revision made at the end of July was a step taken too early, while some have argued it was a step too late.

Taking a brief look back on monetary policy, since April, the Bank has been consistent with its intention that, if the outlook for economic activity and prices is realized, it will adjust the degree of monetary accommodation.

However, I believe it is important for the Bank to take stock -- even if only in retrospect -- of whether this intention was adequately conveyed to the market and whether there was a more appropriate way for the Bank to respond to market reactions, and thereby continuously seek to improve its communication with the market.

I also think the Bank needs to continue to keep a close watch on developments in financial and capital markets and their impact on economic activity and prices.The market currently expects the pace of short-term interest rate hikes to be moderate (Chart 13).

Of course, the pace of the Bank's rate hikes could only be at this level depending on developments in economic activity and prices.

If the Bank does raise the short-term interest rate at this pace, however, the rate will likely not reach the neutral interest rate by the second half of the projection period.

In addition, the possibility that this could further heighten upside risks to prices, which are of concern, or result in the Bank having to conduct rapid interest rate hikes at a later stage, cannot be ruled out.

To avoid such risks, I think the Bank needs to raise the policy interest rate in a timely and gradual manner, while giving due consideration to developments in financial markets as well as paying attention to how the economy and prices respond.Chart 13: Market Expectations for the Bank's Policy Interest RateNotes: 1.

The figure for the present is the 3-month yen OIS rate.

Figures for 3, 6, and 9 months ahead are 3-month forward rates, those for 12 and 18 months ahead are 6-month forward rates, and those for 24 and 36 months ahead are 12-month forward rates, all calculated from the yen OIS rates.

Figures are as of September 5, 2024.2.

The projection period is from fiscal 2024 to fiscal 2026.Source: Bloomberg.I would also like to consider the impact on various economic agents of raising the short-term interest

rate.

Roughly

speaking,

since

net

borrowers

pay

interest

and

net

savers

receive interest,

raising

the

short-term

interest

rate

increases

the

burden

on

net

borrowers

and increases

interest

income

for

net

savers.

Therefore,

the

impact

of

raising

the

short-term interest rate differs depending on, for example, whether a household has a housing loan and whether a firm has borrowings or has savings in excess of its borrowings.

Furthermore, I think it is necessary to pay attention both to the channels through which short-term interestrate hikes affect economic activity and to the changes in the economic and price situation that led to the rate hikes, in addition to interest rate developments.For example, looking at household savings and liabilities by age group of the household head, households in their 40s or younger have larger liabilities, while those in their 50s or older have larger savings (Chart 14).

Thus, disregarding various assumptions, interest rate hikes, on average, tend to increase the burden on households in their 40s or younger and be more beneficial for those in their 50s or older.

When considering the impact of interest rate hikes, however, it is also necessary to take into account the fact that (1) the extent to which shortterm interest rate hikes are reflected in mortgage rates depends on the decisions of the lending financial institutions and, in many cases, a mechanism is in place to prevent sudden increases in

monthly

loan

repayments

and

(2)

many

households

with

a

housing

loan

are

working households, some of which benefit from wage increases.Chart 14: Household Savings and LiabilitiesNote: Figures are 2023 averages for two-or-more-person households.Source: Ministry of Internal Affairs and Communications.Households in their 50s or older have significant net savings, and their interest income is expected to increase in line with a rise in deposit interest rates -- although the extent of the rise will depend on the decisions of financial institutions.

Moreover, an increase in stable interest

income

is

highly

likely

to

improve

the

sentiment

of

households

that

have

been reluctant to withdraw the principal of their deposits, preferring to save up for retirement.Turning

to

the

corporate

sector,

while

firms

have

long

been

net

savers

on

a

flow

basis, reducing borrowings and accumulating funds on hand, the proportion of debt-free or de facto debt-free

firms

--

defined

as

firms

whose

cash

and

deposits

exceed

their

total

amount

of borrowings -- has been increasing (Chart 15).

Hence, the corporate sector is likely to be more resilient

to

the

impact

of

short-term

interest

rate

hikes

than

in the

past.

In

addition,

solid corporate profits are expected to mitigate the effects of higher interest payments if the outlook for Japan's economy mentioned earlier is realized -- namely, that the economy will grow at a pace above its potential growth rate, as a virtuous cycle from income to spending gradually intensifies.

Furthermore, on a different note, if interest rates rise and function effectively as a hurdle rate, firms, to survive, will be pressured to concentrate their business resources in areas that earn enough profits to cover the interest cost -- in other words, businesses with high added

value. 1 Consequently,

this

is

expected

to

stimulate

business

metabolism

and

raise productivity.Chart 15: Firms' Financial Condition Savings-Investment Balance Number of FirmsNotes: 1.

In the left panel, figures are based on the Flow of Funds Accounts .2.

In the right panel, figures show the number of privately owned establishments from the Economic Census for Business Frame and the Economic Census for Business Activity ( Establishment and Enterprise Census up to 2006, interpolated for years with no data), decomposed using the shares of each group based on data from Teikoku Databank.

Figures cover privately owned establishments (single-unit establishments and head offices).Sources: Ministry of Internal Affairs and Communications; Small and Medium Enterprise Agency; Teikoku Databank; Bank of Japan.1

Regarding the hurdle rate function of interest rates, see Tamura, N., "Economic Activity, Prices, and Monetary Policy in Japan," speech at a meeting with local leaders in Aomori, March 27, 2024, rate hikes will also have an impact on the government.

Speaking in general terms, it is important to steadily ensure the market credibility of fiscal management.The Bank will continue to attentively assess the impact of changes in the policy interest rate, including

the

effects

described

earlier,

and

conduct

monetary

policy

as

appropriate,

in response to developments in economic activity and prices as well as financial conditions.Thank you.