Hajime Takata: Economic activity, prices and monetary policy in Japan
Central bank: boj | Type: speech | Date: 2025-07-03

Bank

of

Japan J u l y 3 ,

2 0 2 5

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

## TAKATA HajimeMember of the Policy Board(English translation based on the Japanese original)

## I.

Economic Activity and PricesI will begin by talking about developments in economic activity and prices.Overseas economies have grown moderately on the whole, although some weakness has been seen in part, reflecting trade and other policies in each jurisdiction.

In the April 2025 World Economic Outlook (WEO), the International Monetary Fund (IMF) projects that the global economy will be

heavily

affected

by

U.S.

tariff

policy, while

also

highlighting further downside risk (Chart 1).

However, looking at hard data, recent economic indicators suggest that

the

U.S.

economy has

grown moderately, despite concerns about the impact of tariff policy.

While the Federal Reserve has kept its policy interest rate unchanged since the January 2025 Federal Open Market Committee (FOMC) meeting, some market participants expect it to start cutting the policy rate again (Chart 2).

As for the outlook, I am of the view that a sharp economic slowdown triggered

by

credit

contraction, which

was

common during

past economic downturns, is unlikely, owing to the sound balance sheets of households, firms, and financial

institutions,

among

other

factors.

Instead

of a

serious

recession,

I have been expecting the U.S. economy to grow only at a slower pace than its potential growth rate, mainly affected by a deterioration in consumer sentiment.

Still, it is necessary to bear in mind that such an economic slowdown depends on the policies of the U.S. administration, and hence there are extremely high uncertainties, both upside and downside.

Even if the economy remains robust

at

the

moment, the

longer concerns

about

tariffs remain, the greater the downward pressure on economic activity could become, due to heightened uncertainty, and thus it

is

necessary to carefully examine the

situation from

a

long-term

perspective.

Meanwhile, as I will elaborate later, since it took office, the new U.S. administration has given priority to policies, such as tariffs, that have a negative impact on economic growth.

If it were to pursue policies that have a positive impact on economic growth, such as reducing domestic taxes, the growth rate of the U.S. economy could be higher than expected.

With regard to overseas economies, Europe, the United States, and China and other emerging economies have all leaned toward accommodative policies on both the fiscal and monetary fronts.

With the

same

policy direction

adopted

around

the

world, attention

is also warranted

on

the possibility that this could, in combination, exert greater-than-expected upward pressure on economic activity and prices.The aforementioned impact

of

U.S.

tariff

policy

will

likely

push

down Japan's

economy though such channels as a slowdown in overseas economies, a decline in domestic corporate profits and the associated slowdown

in wage

increases,

and postponement of firms'

and households' spending due to increased uncertainty.

Against this backdrop, the Bank of Japan revised downward its outlook both for the GDP growth rate and prices in the April 2025 Outlook for Economic Activity and Prices (Outlook Report), compared with those presented in the January Outlook Report (Chart 3).Nonetheless, in Japan's corporate sector, corporate profits have remained on an improving trend recently.

Based on the Japanese Trade Union Confederation's (Rengo) sixth aggregate results, high levels of wage increases have also been agreed in the 2025 annual spring labormanagement wage negotiations (Chart 4).

In the household sector, private consumption has maintained

its

moderate

increasing

trend

against

the

background

of

an

improvement

in employee income, despite weakness in consumer sentiment due to the impact of price rises and other factors (Chart 5).

The inflation rate has been increasing recently due to the rise in food

prices,

such

as

rice

prices (Chart

6).

However,

private

consumption

is

expected

to continue

increasing

moderately,

with

wage increases

catching

up

with higher prices, reflecting the rise in wage growth and downward pressure on inflation mainly exerted by a decline in import prices.Looking at medium- to long-term inflation expectations of various economic entities to assess underlying inflation, expectations have continued to rise steadily (Chart 7).

In addition, the growth in the GDP deflator -- which indicates domestic inflationary pressure and had been mainly led by unit profits -- has increasingly been driven by a rise in unit labor costs since 2024, reflecting wage increases.

As a result, the growth rates of unit profits and unit labor costs are becoming balanced, and signs of homemade inflation have finally emerged in that inflationary

pressure is

stemming not

only

from

import

price

factors

but from

domestic factors.

In this regard, high levels of wage increases agreed in the 2025 annual spring labormanagement wage negotiations suggest that these trends will likely continue.With firms facing supply-side constraints due to labor shortages -- in other words, a shift to a "labor shortage economy," firms' wage- and price-setting behavior has been active.

As far asrecent domestic developments suggest, I believe Japan's economy is at a stage where the price stability target is close to being achieved.

Although I expect that this scenario will remain broadly unchanged even after the announcement of reciprocal tariffs in April, I would like to closely monitor whether the momentum toward achieving the price stability target, which has finally started to operate, will not be dampened by U.S. tariff policy.

In particular, given the transmission channels to Japan's economy of the impact of U.S. tariff policy, I think it is necessary to pay attention to whether any adverse impact of tariff policy will materialize in terms of the following four points.

First, whether business fixed investment will weaken, due to

heightened

uncertainty.

Second,

whether

exports

will become sluggish, given a global economic slowdown caused by U.S. tariff policy.

Third, whether a decline in corporate profits will restrain the momentum for wage increases toward 2026, while also restraining selling prices.

And fourth, whether the yen will appreciate, amid speculation over various policies of the

U.S.

administration,

thereby

pushing

down

corporate

profits

and

import

prices,

for example.

I am paying particular attention to the possibility of significant market volatility, depending on the expectations for the new U.S. administration's policies as described in the fourth point.

## II.

Recent Conduct of Monetary PolicyLet me now present my views on the Bank's conduct of monetary policy.The Bank decided to raise the policy interest rate to around 0.5 percent in January 2025.

This is because the Bank judged it appropriate to adjust the degree of monetary accommodation from the perspective of sustainable and stable achievement of the price stability target of 2 percent, as Japan's economic activity and prices had been developing generally in line with the Bank's outlook and the likelihood of realizing the outlook had been rising.As I mentioned earlier, as far as domestic factors suggest, the price stability target is close to being achieved.

In this situation, real interest rates, particularly the short-term rate, have been significantly negative, and accommodative financial conditions have been maintained (Chart 8).

Against

this

background,

I

consider

that

the

Bank should

continue

to

shift

gears

as appropriate; that is, proceed with further adjustment of the degree of monetary accommodation if it is confirmed that positive corporate behavior -- such as solid businessfixed investment, sustained wage hikes, and a continued price pass-through of cost increases -- is being maintained.Yet, with the likelihood of a deceleration in the U.S. economy due to the impact of tariff policy,

careful

monitoring continues

to

be

warranted

on

the

risk

that

the

divergence

in monetary policy stance due to the difference in economic cycles between Japan and abroad could bring about high volatility in financial markets, particularly foreign exchange markets.

In fact, looking back on its previous five cycles of policy interest rate hikes, excluding the most recent one, since Japan's shift to a floating exchange rate system in the 1970s, the Bank turned to rate cuts after the Federal Reserve cut its rate.

In this sense, if the Federal Reserve resumes its rate cuts, that may reduce the flexibility of the Bank's monetary policy.

Having said that, as I mentioned earlier, the U.S. economy is unlikely to see a serious recession, and the current situation is different from the periods after the collapse of the dot-com bubble around

2000

and

following

the

Global

Financial

Crisis

in

the

late

2000s.

Under these circumstances, I believe that the Bank is currently only pausing its policy interest rate hike cycle and should continue to make a gear shift after a certain period of "wait and see." There is persistent speculation of a rebound in U.S. inflation due to the imposition of reciprocal tariffs.

With

the

likelihood

of

policy

interest

rate

cuts

diminishing,

the

Federal

Reserve's policy conduct warrants attention through this summer.Given that uncertainties regarding various U.S. policies remain high, I believe that the Bank is

required

to

conduct

monetary

policy

in

a

more

flexible

manner

without

being

too pessimistic.

This is because the Bank may need to nimbly shift back to the rate hike cycle in response to policy changes in the United States, in addition to taking action in the case of increased downward pressure on the economy.

At the same time, to maintain the momentum toward achieving the price stability target, which has finally come close, I believe that the Bank also needs to maintain its current accommodative monetary policy stance and thereby support the economic activity of firms and households, so that their behavior does not become overly negative.At

the June

2025 Monetary

Policy

Meeting

(MPM), the

Bank

conducted

an

interim assessment of the plan for the reduction of its purchase amount of Japanese government bonds(JGBs), taking into account the opinions collected from market participants.

Based on the assessment, the Bank decided to continue to cut down its monthly purchase amount by about 400 billion yen each calendar quarter until January-March 2026, maintaining the amount and pace of the reduction decided in July 2024 (Chart 9).

Thereafter, the amount of purchases will be reduced by about 200 billion yen each calendar quarter, so that it will be about 2 trillion yen in January-March 2027.

By reducing JGB purchases, this plan is intended to normalize the JGB market and improve its functioning.

Since the turmoil of bond markets at home and abroad in April 2025, yields on super-long-term JGBs have risen significantly, and market fragmentation has in turn occurred between the super-long-term zone and shorter maturity zones.

At

the

same

time,

market

correlations

have

been

disrupted,

as

seen

in

the

rapid widening of swap spreads (Chart 10).

Risk premiums have risen in particular segments of the yield curve, and the results of the latest May 2025 Bond Market Survey suggest a substantial decline in the degree of bond market functioning.

As background to these developments, it has been pointed out that life insurers' demand for super-long-term JGBs has been marginal and that it has become difficult for dealers to engage in market making due to market volatility.

Thus, I believe that the Bank should proceed with the reduction in its JGB purchases based on supply and demand conditions and liquidity of JGBs by maturity, with a view to improving the functioning of the market as a whole.The Bank's plan for the reduction of its purchase amount of JGBs stipulates that, in principle, long-term interest rates are to be formed in financial markets, and that the Bank will reduce its purchase amount of JGBs in a predictable manner, while allowing enough flexibility to support stability in the JGB market.

In my view, the Bank's JGB purchases thus far have served to hold back the amount of JGBs in the market by increasing the Bank's JGB holdings.

In contrast, the reduction in purchases will supply the market with some portion of JGBs that the Bank has purchased to date, in effect resulting in an increase in the amount of JGBs in the market.

Taking this into consideration, it can be said that the market is in a phase with one of the largest supplies of JGBs compared to the past.

Chart 11 shows historical developments in the net issuance of JGBs, representing the annual change in the outstanding amount of JGBs issued.

By deducting the annual change in the Bank's JGB holdings -- which factors in the amount of the Bank's JGB purchases that year -- from the net JGB issuance, the annual change in the outstanding amount of JGBs in the market can be derived, which represents, in effect,the

supply

of

JGBs

to

the

market.

Thus,

the

impact

of the

reduction

in

the

Bank's

JGB purchases is reflected in this chart.

As can be seen, there has been an increase in the supply of JGBs to the market since the start of the reduction in the Bank's JGB purchases in 2024, and the figure for fiscal year-end 2025 is estimated to reach a level comparable to that in the 2000s, when the annual change in the outstanding amount of JGBs in the market peaked.

Given this, to prevent instability associated with the increase in the supply of JGBs to the market, I believe it is necessary to adjust the amount of the reduction and carefully examine how the market responds.A rise in the risk premium on super-long-term JGBs tends to induce a deterioration in market functioning, with volatility spilling over to the entire yield curve.

It should be noted that this may unintentionally give rise to the risk of monetary tightening effects transmitting widely across the market.

Also, the formation of the risk-free yield curve in a stable JGB market serves as support for Japan's financial infrastructure.

Needless to say, the reduction in the Bank's JGB purchases does not aim at giving considerations to the fiscal situation.

That said, as I mentioned earlier, since the reduction in purchases in effect supplies the market with JGBs, I believe it is also necessary, from the perspective of improving the functioning of the market

as

a

whole, to ensure

the stability of the

market

while

maintaining

close communication among authorities.

Looking back over the past year, there have been some unexpected changes in the market structure, such as the weakening investment demand for super-long-term JGBs.

Given this, I believe it is necessary for the Bank to conduct another interim assessment of the plan for the reduction of its purchase amount of JGBs at the June 2026 MPM, and make amendments depending on the circumstances.

## III.

Looking

Back

at

a

Half

Century

of

Trade

Friction

and

Its

Impact

on

Japan's EconomyU.S. tariff policy has been drawing a great deal of attention.

As I mentioned earlier, the Bank revised downward its outlook for the GDP growth rate and prices in the April 2025 Outlook Report in view of the tariff policy.

The various policies of the new U.S. administration have drawn comparisons with those known as the Nixon shock of 1971.

Thus, looking back at Japan-U.S. trade friction since the 1970s, I would like to present my views from a historicalperspective on the possible downward pressure on economic activity caused by the recent U.S. tariff policy.

## U.S. Current Account and Trade Deficits from a Long-Term PerspectiveWhat must always be taken into account when discussing Japan-U.S. trade friction over the past half century is the existence of the U.S. current account deficit (Chart 12).

To start with, the

background

to

the

1971

Nixon

shock

was

the intention

to

stem

the

outflow

of

gold reserves resulting from the continuing U.S. current account deficit.

The main cause of this deficit, which has continued for over half a century, is the trade deficit.

From the 1980s to the 1990s, the U.S. trade deficit was mainly with Japan and (West) Germany, but Japan accounted for the overwhelming proportion of the overall deficit (Charts 13 and 14).

At its peak in 1991, Japan's share of the U.S. trade deficit reached 53 percent, leading observers to frame the U.S. trade deficit issue as a Japan-U.S. trade issue.

At the time, foreign exchange markets were expected to function as a venue to correct the current account deficit, and the exchange rate adjustment pressure caused the yen and the deutsche mark to appreciate in Japan and (West) Germany, which both recorded a trade surplus.

In this situation, the U.S. dollar/yen exchange rate drew particular attention.Chart 15 shows historical developments in the U.S. dollar/yen exchange rate and Japan-U.S. trade friction.

Trade friction occurred mainly in the textiles and steel industries in the 1970s, but this shifted to automobiles and household electrical appliances in the 1980s, and spread to semiconductors in the 1990s.

Turning to foreign exchange markets, monetary authorities aimed to improve the trade balance and agreed on concerted market intervention to rectify the U.S. dollar's appreciation under the Plaza Accord in 1985.

Furthermore, in 1995, which can be said to be the peak of Japan-U.S. trade friction in that decade, the yen appreciated to a level of nearly 80 yen against the U.S. dollar.My

view

is

that

the

Japan-U.S.

trade

friction

that

intensified

from

the

1970s,

and

its consequences, are related to Japan's long-term stagnation following the collapse of the bubble economy.

In other words, I believe that the post-bubble long-term stagnation was caused by the following two main factors: (1) asset deflation, and (2) a prolonged business environment in

which

it

was

difficult

to

depend

on

external

demand

due

to,

for

example,

the

yen'sappreciation caused mainly by trade

friction.

Looking back

once again, Japan's

economy continued to experience low growth from the 1990s, following the collapse of the bubble economy.

Although

a variety of structural factors, including

demographic

changes, contributed to the slowdown in growth, I believe that the major cause was the change in corporate behavior in the post-bubble period.

To elaborate, let us take a look at Chart 16, which is also relevant to the two main factors I have just mentioned.

As the chart shows, in the context of significant asset

deflation,

an increasing number

of firms sought to pursue management with minimum assets by paring down assets on their balance sheets and reining in investment.

Many more firms also engaged in business restructuring, in which they held down margins and personnel expenses in their income statements to cope with mounting international competition mainly caused by trade friction.

For individual firms, these moves were

a

rational

response

to

the

changing

business

conditions.

From

a

macroeconomic perspective, however, this approach caused Japan to fall into a shrinking equilibrium due to the "fallacy of composition" -- assuming that what is true of one member of a group is true for the group as a whole.

In the pursuit of management with minimum assets and business restructuring,

firms

not

only

reined

in

business

fixed

investment

but

also

suppressed investment in human capital.

These developments together are considered to have brought down Japan's potential growth rate for a prolonged period.Let me elaborate on asset deflation, which is the first main factor behind Japan's long-term stagnation following the collapse of the bubble economy.

At its peak in the 1980s, Japan accounted for nearly half of global market capitalization.

Due to its growing presence in the asset market, as well as the fact that it accounted for nearly half of the U.S. trade deficit at the time, Japan was increasingly seen as an economic threat, and this is likely what made trade

friction

even

more

acute.

Subsequently,

from

the

1990s,

stock

prices

in

Japan

fell sharply and real estate prices stagnated (Chart 17).

A significant decline in capital bases in real

terms drove firms to curtail investment and reduce interest-bearing debt.

In addition, firms' concerns over funding stemming from post-bubble financial system instability led to hoarding

cash

and

deposits.

Historically,

European

countries

and

the

United

States

also experienced

asset

deflation

during

the

Great

Depression in

the

1930s,

and

so

did

some Scandinavian countries in the early 1990s.

It has been pointed out that, for these countries, it was the expansion in external demand arising from currency depreciation that contributed torecovery in economic activity.

For example, the departure from the gold standard, among other factors, resulted in currency depreciation at the time of the Great Depression, leading to an expansion in external demand that helped the countries overcome deflation.

In some Scandinavian

countries in

the

early

1990s,

the

boost

to

demand

arising

from

German reunification, in addition to currency depreciation, played a similar role.In contrast, in Japan, despite the asset deflation, the harsh competitive environment vis-à-vis overseas economies, in which it was difficult to depend on external demand, was prolonged, mainly due to trade friction.

This is the second main factor that caused the post-bubble longterm stagnation, which led firms to engage in business restructuring.

In the aftermath of World War II, Japan had a geopolitical benefit for many years from the tailwind of global trade, serving as the manufacturing hub for the Western bloc.

However, after the fall of the Berlin Wall in 1989, the geopolitical environment shifted, with the Soviet Union losing its power.

Japan started to be seen as an economic threat, and this led trade friction with the United States

to

become

intensified

more

than

ever.

The

yen,

meanwhile,

appreciated

rapidly

in foreign exchange markets (Chart 15).

While trade friction involved not only Japan but also West Germany until the 1980s, Japan became the sole target in this conflict following German reunification, and this situation is also considered to have played a significant part in creating an environment in which it was difficult to depend on external demand.

Japanese firms across a wide range of sectors, including those in the automobile industry, were called on to shift their

production

sites

overseas,

leading

to

a

hollowing

out

of

domestic

industries.

In

the semiconductor sector, for example, trade friction led to a placement of quotas that forced Japanese firms to curtail their share of production, resulting in a shift of major semiconductor production sites to other Asian economies, such as South Korea and Taiwan. 1 Thus, while Japan's presence was suppressed, being regarded as an economic threat, the rise of emerging economies -- especially those in Asia -- was promoted.

China's entry into the World Trade Organization (WTO) in 2001 can be understood in this context.

To sum up, under the trade friction until the 1990s, Japan, which accounted for the lion's share of the U.S. trade deficit,1 Under the Japan-United States Semiconductor Agreement concluded in 1986 and 1991, the United States requested Japan to set a minimum target for the foreign share in the Japanese semiconductor market.

It has been suggested that, partly as a result of this, Japan's share of semiconductor production, which stood at around 70 percent in the first half of 1980s, declined drastically from the 1990s.was hampered not only by the continued appreciation of the yen but also by direct measures such as export quotas and voluntary export restraints.The

upshot

is

that,

despite

the

yen's

appreciation,

Japanese

firms

left

their

export

prices unchanged to maintain price competitiveness.

This led to the entrenchment of a situation where these firms needed to pursue management aimed at business restructuring and to hold down margins while being cautious about raising wages.

In this situation,

firms chose to absorb increases in the price of raw materials over the long term by cutting costs rather than by passing the higher costs on to selling prices, and they eventually grew accustomed to this practice as being the norm.

As a result, starting with export-oriented manufacturers at the top of the supply chain, cost reduction spread broadly across multiple layers of affiliated firms that maintained vertical corporate ties.

On this score, U.S. and European firms achieved a horizontal division of labor by capitalizing on global supply chains, and focused on areas with

high

added

value,

such

as

planning

and

development.

Meanwhile,

many

Japanese manufacturers continued

with a business

model

of

vertical

integration

and

focused on maintaining

existing manufacturing

processes,

which

likely

gave

further

impetus

to

cost reduction.

Japanese firms prioritized maintaining employment over raising employee wages and consequently established

a

work-sharing kind

of approach

to

setting wages.

In other words,

firms

maintained

existing

employment

as

far

as

possible,

mainly

of

full-time employees, while holding back on new hiring and restraining wage increases. 2 A series of events took place around this time that were emblematic of the situation. 3 In 2002, a major Japanese automaker decided on zero base pay increases, which was dubbed a "shock." In December of that year, the Japan Business Federation (Keidanren) declared an end to annual spring labor-management wage negotiations.

Moreover, Rengo announced in 2003 that it would not make unified demands for base pay hikes.

It took nearly two decades for this situation to be reversed, until the significant rise in base pay achieved in 2023.2 It has been pointed out that the restraint on new hiring made it difficult for the generation entering the job market in the 1990s and early 2000s to find employment and swelled the ranks of non-regular employees -- a period referred to as the employment ice age.3 See Watanabe, T., Bukka o kangaeru: Defure no nazo, infure no nazo [Thinking about prices: The mystery of deflation and inflation] (Tokyo: Nikkei Business Publications, 2024).

In this book, the author

offers

the

hypothesis

that,

following

the

Japan

Federation

of

Employers'

Associations (Nikkeiren) indicating its stance in 1995 of advocating restraints on wages, labor and management held down wage hikes in exchange for protecting full-time employment.In sum, my assessment is that, although Japanese firms weathered past trade friction and the cost competition with firms overseas due to the yen's appreciation by means of restructuring, mainly in terms of wages, and of cost reduction, including involving affiliates, this had the side effects of creating the norm that wages and prices do not rise and of bringing on the employment

ice

age.

It

also

likely

ushered

in

a

decline

in

Japan's

potential

growth

rate stemming from a lack of investment.

## Shift Away from Past Trade Friction, and Improvement in Asset PricesLet us take a look at the situation in recent years.

Since the 2010s, the asset deflation that led firms

to

pursue

management

with

minimum

assets

on

their

balance

sheets

has

improved significantly, as asset prices have risen, mainly in the stock and real estate markets (Chart 17).

Firms have also managed to shift away from business restructuring, with the dissipation of the continued excessive appreciation of the yen that drove severe international competition in

terms

of

firms'

income

statements.

The

landscape

of

trade

friction

has

also

changed significantly.

Japan's

share

of

the

U.S.

trade

deficit

has

recently

fallen

to

6

percent,

a tremendous change from the early 1990s, when it accounted for more than 50 percent (Charts 13 and 14).

Today, with Japan finding itself in a very different geopolitical position compared with the period around 1990, production sites have been brought back home out of concern over economic security, as exemplified by the shoring up of semiconductor production in Kumamoto and Hokkaido prefectures.

This context is entirely different from when Japan was the target of U.S. "containment" strategies, so to speak, during the trade friction of the 1990s.On the other hand, it has taken a long time to shift the persistent norm that wages and prices do not rise.

An estimate shows that a shift in the corporate behavior mired in such a norm could take longer than expected, perhaps the decade it takes to form the next generation. 4 On this

point, it has been suggested that, in addition to the lower funding costs transmission channel, the financial and capital markets channel (stock prices and foreign exchange rates)4 Taking an estimate using stock prices as an example, the following speech refers to the possibility that it may take time to recover from a long-term negative experience in the post-bubble economy: Takata, H., "Economic Activity, Prices, and Monetary Policy in Japan," speech at a meeting with local leaders in Miyagi, February 19, 2025,

also

significantly

effective

in

translating

the

benefits

of

lower

interest

rates

into

an improvement in the output gap (Chart 18).

These findings indicate that the Bank's monetary easing was likely to have contributed to the shift away from the asset deflation and the socalled six headwinds -- including the headwind of the yen's appreciation -- both of which had prompted the changes in corporate behavior in the post-bubble economy. 5 I believe that the Bank's patient continuation of monetary easing over many years, and the resulting support for rises in asset prices and for the reversal in the excessive appreciation of the yen, laid the groundwork for reaching the inflection point of the norm shift, marking a historic change since the collapse of the bubble economy.

## Consideration of the Impact of Recent U.S. Tariff PolicyI have looked back on the history of trade friction over the past half century since the 1970s.

On this basis, I would now like to present my views on the recent U.S. tariff policy.

Although the policy is intended to bring manufacturing back to the United States, given that the country capitalizes on global supply chains and maintains high productivity through business models involving a horizontal division of labor, reshoring of U.S. manufacturing could actually result in restraining wages.

For this reason, let me first note that I think it will be difficult for the United States to sustain high tariffs. 6As seen in the IMF's forecasts presented in Chart 1, various institutions and firms, including market participants, have recently revised down their economic outlook in response to the5 The

following have

been

pointed

out

as the

six

headwinds

faced

by

Japanese

firms:

the

yen's appreciation;

delayed

negotiations

on

economic

partnership

agreements;

high

corporate

tax

rates; rigidity in the labor market; environmental regulations; and high electricity costs.

For details, see, for example,

Cabinet

Office, Annual

Report

on

the

Japanese

Economy

and

Public

Finance

2021 --Towards a resilient Japanese economy: Accelerating innovation towards an economic society with strength and flexibility , September 2021.

This report is a summary of the Japanese original.6 Although the tariff policy is also intended to reduce trade deficits, mainstream economics holds that elimination

of

constant

current

account

deficits,

or

correction

of

external

imbalances,

should

be achieved gradually through market mechanisms.

It has been pointed out that policy intervention or any action that could undermine confidence in the currency will hinder the path to smooth correction.

In Gendai nihon keizai: Makuroteki tenkai to kokusai keizai kankei [The modern Japanese economy: In relation to macroeconomic and global economic developments] (Tokyo: University of Tokyo Press, 1988), Professor Ryutaro Komiya argues that the U.S. current account deficit is attributable to its macroeconomic balance and undersaving, and that the impact of a single country's exchange rate adjustments is limited.U.S. tariff policy.

These downward revisions were made even in the absence of significant deterioration in current economic developments, on the assumption that downward pressure on economic activity will materialize in the future.

This approach can be likened to a "planned suspension"

of

public

transportation; in

other

words,

the

outlook

has

been

revised

down preemptively ahead

of the

advent

of the

"typhoon"

of reciprocal tariffs.

Therefore,

if the underlying assumption were to be revised, the economic outlook might accordingly change significantly.

On this point, among the public policy commitments outlined by the new U.S. administration, the details of fiscal policy are still unclear.

Partly because of this, various institutions' and firms' economic outlook appears to have factored in more of an economic deceleration caused by the tariff measures (Chart 19).

It should be kept in mind that fiscal policy

measures,

such

as

tax

cuts,

and

deregulation,

all

of

which

are

included

in

the administration's commitments, could contribute to boosting future U.S. economic growth.Here, let me reconfirm the direct impact of tariff impositions, with reference to supply and demand curves.

Let us take a look at Chart 20.

As shown in the left panel, the imposition of a tariff causes an upward shift in the supply curve, resulting in an increase in the price level from P 0 to P 1 and a decrease in the sales volume from S 0 to S 1 .

As U.S. importing firms bear the burden of tariffs, U.S. consumers are also expected to bear the burden in the form of tariffs being passed on to selling prices (denoted by (1) in the left panel).

Exporting firms will also bear a burden in the form of the drop in income arising from the imposition of tariffs (denoted by

(2) in

the left panel).

The

extent

to

which the

burden

of tariffs

is

passed

on

to

U.S. consumers will depend on the price elasticity of demand for the products in question.

For necessities for which domestic alternate production is difficult within the United States, the slope of the demand curve tends to be vertical, making it easier for tariffs to be passed on to prices.

Meanwhile, if exporting firms do not pass on tariff hikes to prices, as some of them have announced recently, sales volumes will not change, and firms will need to pay significant costs equivalent to tariffs (denoted by (3) in the left panel).

The right panel of Chart 20 shows the

impact

of

tariff impositions from the perspective of exporting countries.

In a

manner corresponding to the

left panel,

a

decline in

sales

volume

due

to

higher

prices,

that

is,

a downward shift in the demand curve -- or a demand shock -- occurs, putting the economy under deflationary pressure.

In sum, for exporting countries on which tariffs are imposed, if they pass on higher tariffs to prices, they will see a fall in demand (denoted by (2) in the leftpanel), and if they do not, they will need to pay the costs equivalent to tariffs (denoted by (3) in the left panel), either way shouldering a significant burden.Next, I would like to compare the trade friction until the 1990s with the recent U.S. tariff policy.

Let me first reiterate what Japan went through under the trade friction.

As was shown in Chart 14, Japan had an overwhelming presence in the U.S. trade deficit.

In addition to the yen's appreciation, this resulted in direct measures by the U.S. government, such as imposing export quotas and encouraging voluntary export restraints on Japanese products.

Although they were not the imposition of tariffs per se, these measures likely caused the upward shift in the supply curve, as shown in the left panel of Chart 20, and Japan alone faced deterioration in its competitive environment.

To maintain competitiveness vis-à-vis other economies in the U.S.

market,

Japanese

firms

kept their

U.S.

dollar-denominated

selling

prices

unchanged despite the yen's appreciation, and thereby avoided the price pass-through.

Consequently, they faced a severe impact to the extent that they had to bear the burden denoted by (3) in the left panel

of

Chart

20.

They dealt with

this

burden by reducing costs

through

business restructuring, under which they held down wages and margins.

In fact, research has shown that price markups of Japanese firms remained significantly suppressed compared with other countries for a long time. 7By contrast, unlike the trade friction until the 1990s, recent U.S. tariff policy targets a wide range of countries and regions, so that Japan is not the only one affected.

Moreover, as a result of

Japan's

industrial

advances

over

around

three

decades,

some

industries --such

as automobiles, semiconductors, and basic materials, including steel and chemicals -- have seen an increase in the weight of products for which alternate production is limited within the United

States.

In

this

situation,

the

price

elasticity for

their

products

may

have declined.

Therefore, it will likely be easier for Japanese firms to pass on the recent tariff hikes to selling prices than it was in the past.

Although the imposition of tariffs will inevitably have an impact in the form of lower demand, the extent of the impact is unlikely to be greater than what Japan went

through

in

the

1990s.

In

addition,

if

tax

cuts

and

other fiscal policy

measures are implemented

in

the

United

States,

depending

on

their

specifics,

an

increase

in

U.S.7 See Aoki,

K.

et

al.,

"Determinants

of

Price

Markups

at

Japanese

Firms

and

Implications

for Productivity," Bank of Japan Working Paper Series , no. 24-E-15 (December 2024).consumers' purchasing power could, combined with the impact from improved asset prices, drive recovery in the sales volume from S 1 to S 0 by shifting the demand curve upward, as shown in Chart 21.

Thus, the impact on Japan's economy, particularly corporate profits, will likely be limited, at least compared with the period of trade friction around 1990.

In this context, the tariff policy is unlikely to bring about the kind of corporate behavior that leads to a shrinking equilibrium, such as restraining wages, which was once common in Japan.I

would also like to point out that improvement in Japanese firms' financial positions has made them more resilient to global shocks.

As Chart 16 illustrates, in terms of their balance sheets, firms have seen a reduction in debt, in addition to an improvement in asset prices; they have reduced excessive interest-bearing debt since the collapse of the bubble economy and thus achieved a rise in their capital adequacy ratios and an improvement in their financial positions, with their interest burden falling to the extent that interest income exceeds interest expenses (Chart 22).

In terms of income statements, Chart 23 shows that corporate profits expanded more than eightfold in fiscal 2023 over the second half of the 1990s, reaching the highest level on record of around 80 trillion yen, and a further expansion is likely for fiscal 2024.

The current situation of corporate profits remaining at

high levels

differs

from the economic recovery phase in the 2000s, and this has led to an increase in the overall level of corporate value.

It can be said that Japanese firms have built up their resilience against shocks by lowering their break-even points over more than three decades to weather the adverse business environment brought about by trade friction and to

withstand even a

significant appreciation of the yen.

I also think that Japan can be regarded as being a forerunner in that it is one of the few countries that has experience in addressing trade friction.

## Summary: Japan's History as a Forerunner in Addressing Trade FrictionAs I noted earlier, the key to a further gear shift in monetary policy is the sustainability of positive corporate behavior.

It is necessary to closely examine whether the impact of U.S. tariff

policy will

cause Japanese

firms' corporate

behavior

to

revert

to

the

pursuit

of management with minimum assets and business restructuring seen in the post-bubble period.

Chart 24 is a conceptual diagram of how expansion in corporate profits is spreading across the

economy.

From

a

macroeconomic

perspective,

corporate

profits

have

expanded significantly

due

to

factors

such

as

the

efforts

of

firms

and the improved

competitiveenvironment in international markets.

From a microeconomic perspective, however, the use of corporate profits as a source for wage hikes and price pass-through to business partners has been limited due to the norm that wages and prices do not rise.

Firms have channeled most

of

their

profits

into

dividends

and

foreign

investment,

and

have

also

limited

their domestic business fixed investment.

This situation has been improving since 2023 owing to some government initiatives, and it is expected that this improvement will benefit households, small and medium-sized firms, and regional firms equally, thereby achieving a virtuous cycle.

Taking U.S. tariff policy into consideration, I will be paying close attention to whether there is any disruption of these improvements.Looking

back

again

at

trade

friction

over

the

past

half

century, Japan's

real

economy experienced downturns from the 1990s under historically unprecedented situations -- such as the collapse of the bubble economy and mounting international competition.

In this context, firms built up their resilience against shocks by reducing the size of their balance sheets and engaging in business restructuring.

Likely side effects of this, however, were the shrinking equilibrium as a result of factors such as a long-term lack of investment and the norm that wages and prices do not rise.

Japan is finally beginning to break free of this norm not only because of the unconventional monetary measures that the Bank implemented ahead of other central banks, but also because of the "big pushes" that helped to change firms' price-and wage-setting

behavior

over

the

past

few

years.

However,

concerns

have also

arisen

over whether recent U.S. tariff policy will disrupt these improvements.

In fact, in the midst of economic

recovery

in

around

2000

and

in

the

mid-2000s,

Japan's

economy

ended

up experiencing

several

"false

dawns," 8 or

temporary

economic

recoveries, interrupted

by global demand shocks.

My expectation is that Japan will see a "true dawn" this time; I will pay close attention to whether "this time is different" and it will actually materialize. 98 Shirakawa, M., "Way Out of Economic and Financial Crisis: Lessons and Policy Actions," speech at the Japan Society in New York, April 23, 2009,9 Nakaso, H., "Japan's Way toward Strong, Sustainable, and Balanced Growth: Assessment of the potential of the Japanese economy suggests the sun also rises," speech at a meeting hosted by the Japan Society and the City of London Corporation in London, October 5, 2017, looking back at the trade friction over the half past century also reveals that Japan was a forerunner in addressing trade friction by withstanding situations far more stressful than what we face today.

Moreover, it is necessary to make an objective assessment of the differences from the past, not least the improvement in firms' financial positions over the 30 years

since

the

collapse

of

the

bubble

economy.

In

this

sense, I

believe

being

overly pessimistic also poses a considerable risk.

To reiterate, my view is that the Bank needs to support

economic

activity

for

the

time

being

by

maintaining

its

current

accommodative monetary

policy

stance.

At

the

same

time,

I

believe

that

the

Bank

should

gradually

and cautiously

shift

gears

in

its

monetary

policy,

based

on

the

recognition

that

it

has

finally reached the point of returning from the implementation of unconventional monetary measures to policy conduct that is in line with what is seen in normal times, and that the "true dawn" is in sight.

In doing so, the Bank will closely monitor developments in U.S. tariff policy and its impact on Japan's economy.Thank you.

## Economic Activity, Prices, and Monetary Policy in JapanSpeech at a Meeting with Local Leaders in MieJuly 3, 2025TAKATA Hajime Member of the Policy Board Bank of Japan

## Developments in Overseas Economies (IMF's April 2025 WEO)Chart 1Global Growth Rate y/y % chg.Impact of Risk Scenarios on GDP Note: In the right panel, for details of the assumptions of each scenario, see Box 1.1. of the April 2025 World Economic Outlook (WEO).

Source: IMF.Consumer ConfidenceThe U.S. EconomyPolicy Interest RateEmployment and Prices1966/1Q=100%%y/y % chg.Note: In the left panel, figures are from the University of Michigan's consumer sentiment index.

In the right panel, figures are the medians of the target ranges for the federal funds rate.

Figures for participants' projections are the medians of all participants' projections at the FOMC meetings.Sources: Bloomberg; BLS; FRB; University of Michigan.Chart 3

## GDP and Outlook for Economic Activity and PricesGDPOutlook for Economic Activity and Prices (April 2025 Outlook Report)s.a., ann., tril. yeny/y % chg.|

| Real GDP

| CPI (less fresh food)

| CPI (less fresh food and energy)

||--------------------|------------|-------------------------|------------------------------------|| Fiscal 2025

| +0.5

| +2.2

| +2.3

|| As of January 2025 | +1.1

| +2.4

| +2.1

|| Fiscal 2026

| +0.7

| +1.7

| +1.8

|| As of January 2025 | +1.0

| +2.0

| +2.1

|| Fiscal 2027

| +1.0

| +1.9

| +2.0

|| As of January 2025 | -

| -

| -

|Note: In the right panel, figures indicate the medians of the Policy Board members' forecasts (point estimates).Sources: Cabinet Office; Bank of Japan.

## Corporate Sector and Wage Growth

## Corporate Profits

## Wage Growth Rates.a., tril. yens.a., tril. yeny/y % chg.Notes: 1.

In the left panel, figures are based on the Financial Statements Statistics of Corporations by Industry, Quarterly .

Excluding the finance and insurance industries.Sources: Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Ministry of Finance.2.

In the right panel, figures from 1980 to 2014 are those published by the Central Labour Relations Commission, while those from 2015 to 2025 are figures released by Rengo.

Figures for 2025 are based on Rengo's sixth aggregate results.Chart 5

## Private Consumption

## Real Private Consumption

## Employee IncomeNotes: 1.

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

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

Figures for real employee income are based on Bank staff calculations using the CPI (less imputed rent).

Figures from the Monthly Labour Survey are based on continuing observations following the sample revisions.

Figures for 2025/Q1 are March-April averages.Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Bank of Japan.2.

In the right panel, figures for real private consumption are the real Consumption Activity Index (travel balance adjusted) based on Bank staff calculations, which exclude inbound tourism consumption and include outbound tourism consumption.

Figures in angle brackets show the weights in the index.

Figures for 2025/Q2 are those for April.

## CPI Inflationy/y % chg.Source: Ministry of Internal Affairs and Communications.Chart 7

## Inflation IndicatorsComposite Index ofGDP Deflator2.

In the right panel, unit labor costs = nominal compensation of employees / real GDP.Sources: Bloomberg; Cabinet Office; Consensus Economics Inc., Consensus Forecasts ; QUICK, QUICK Monthly Market Survey ; Bank of Japan.

## Real Interest RateReal Short-Term Interest Rate (1-Year)Real Long-Term Interest Rate (10-Year)%%Note: Figures for real interest rates are calculated by deducting inflation expectations from JGB yields for each maturity.

Figures for inflation expectations are based on Bank staff calculations using the expectations of various economic entities (firms, households, and experts) at different horizons.

Specifically, the data used in the calculations are as follows: for firms, the Tankan ; for households, the Opinion Survey on the General Public's Views and Behavior ; for experts, the QUICK Survey , the Consensus Forecasts , and inflation swap rates.Sources: Bloomberg; Consensus Economics Inc., Consensus Forecasts ; QUICK, QUICK Monthly Market Survey ; Bank of Japan.Chart 9

## Plan for the Reduction of the Purchase Amount of JGBs1.

Long-term interest rates: to be formed in financial markets in principleIn principle, the Bank will reduce the planned amount of its monthly purchases of JGBs each calendar quarter as follows.2.

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 markets2. 3.  From April-June 2026 to January-March 2027: about 200 billion yen4.

Until January-March 20265. : about 400 billion yen (the reduction plan decided in July 2024 will be maintained)6.  The Bank will gradually reduce its purchase amount so that it can improve the functioning of the JGB markets in a manner that supports stability in the markets.

## Reduction in a Predictable Manner

## Allowing Enough Flexibility2.

In the case of a rapid rise in long-term interest rates, the Bank will make nimble responses by, for example, increasing the amount of JGB purchases.1.

The Bank will conduct an interim assessment of the plan at the June 2026 MPM.3.

The Bank is prepared to amend the plan at the MPMs, if deemed necessary.

## Degree of Bond Market FunctioningYields on Long-Term and Super-Long-Term JGBsDI for the Degree of Bond Market Functioning%DI

("high" - "low"), % pointsNote: In the right panel, 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.Sources: Ministry of Finance; Bank of Japan.

## Historically Large Annual Change in the Outstanding Amount of JGBs in the MarketChart 11(Supply of JGBs to the market surged due to the reduction in the Bank's purchases)y/y % chg., tril. yen- Notes: 1.

Figures are on a book value basis and exclude short-term government securities.Sources: Cabinet Office; Ministry of Finance; Bank of Japan.2.

Figures for FY2025 are estimated using the Cabinet Office's Economic and Fiscal Projections for Medium to Long Term Analysis (January 2025) and the Bank's plan for the reduction of the purchase amount of JGBs.

## U.S. Current Account(Focus should be on the future course of twin deficits: current account and fiscal deficit)ratio to nominal GDP, %Note: Figures for fiscal balance is on a fiscal-year basis.

Sources: Bureau of Economic Analysis (BEA); Congressional Budget Office (CBO).U.S. Trade Balance by Country (Japan accounted for over half of U.S. trade deficit around 1990)ratio to nominal GDP, %Chart 13

## Largest Shares of U.S. Trade Deficit by Country/Region (China has replaced Japan)19912024Source: IMF.Chart 15

## Historical Developments in U.S. Dollar/Yen Exchange Rate and Japan-U.S. Trade Friction(Trade friction reached its peak in the early 1990s)end of month, yenNote: The descriptions of events in Japan-U.S. trade friction are based on White Paper on International Economy and Trade 2019, etc. Sources: Ministry of Economy, Trade and Industry; Bank of Japan.

## My View on Corporate Behavior in the Post-Bubble PeriodChart 17

## Asset Prices and National Wealth(Japan was seen as an economic threat but then fell into asset deflation)StocksNational WealthLandNote: Figures are based on the SNA.

Dotted lines are based on the 1993SNA (benchmark year: 2000).

## Transmission Channels of Lower Interest Rates- Notes: 1.

Figures are based on a VAR model with coefficient restrictions using eight variables: output gap, interest rates (3-month), interest rate spreads (2-year minus 3-month, 5-year minus 2-year, 10-year minus 5-year), aggregate funding costs, nominal effective exchange rates of the yen, and stock prices.3.

In the right pie graph, figures show the 5-year cumulative effects.2.

Aggregate funding costs are the weighted average of bank lending rates and issuance yields for CP and corporate bonds.Sources: Bloomberg; Bank of Japan; etc.Chart 19

## Policy Status of the New U.S. Administration|

| Policy Status under the NewAdministration

||--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|| Tariffs

| ・ Imposition of reciprocal tariffs on all trading partners (10-50%), based on the results of America First Trade Policy investigations ・ China:54% (of which additional 24% tariffs have been suspended) ・ Canada and Mexico: 25% ( excl.

USMCA-compliant goods ) ・ Steel andAluminum (50%), Automobiles (25%)

|| Immigration

| ・ Declaration of a national emergency and initiation of procedures to control entry and deport undocumented migrants

|| Budget

| ・ Permanent extension of Trump tax cuts and enactment of additional tax cuts under deliberation in the Senate and the House of Representatives ・ Cuts to government spending (establishment of the Department of Government Efficiency [DOGE], offer of early retirement to federal workers)

|| Deregulation, etc. | ・ Declaration of a national energy emergency, promotion of oil and gas field development ・ Cancelation of EV mandates, withdrawal from the Paris Agreement ・ Easing of regulations on financial institutions (temporary shutdown of the CFPB, etc.) ・ Elimination of 10 existing regulations for each new regulation issued |

## Impact of Tariffs: Supply and Demand Curves (1)Tariff-Imposing Country: Supply ShockTariff-Imposed Country: Demand Shock pricepriceNote: The charts are based on Krugman, P., Obstfeld, M., and Melitz, M., International Trade: Theory and Policy , 10th ed. (Pearson, 2014), etc.Chart 21

## Impact of Tariffs: Supply and Demand Curves (2)Tariff-Imposed Country: Increased Demand Due to Fiscal Policy Measures in the Export Destinationprice

## Improvement in Corporate FinanceInterest BalanceCapital Adequacy Ratio tril. yen%Note: Interest balance for small and medium-sized enterprises (SMEs) in the left panel includes dividend income.

Sources: Cabinet Office; Ministry of Finance.Chart 23

## Rapid Expansion in Corporate Profits

## Corporate Profits and Returns to InvestorsLabor Share tril. yenNotes: 1.

Figures are based on the Financial Statements Statistics of Corporations by Industry, Annually , and exclude the finance and insurance industries.Source: Ministry of Finance.2.

Labor share = personnel expenses / value-added.

Value-added = operating profits + personnel expenses + depreciation expenses.

## My View on Mechanism of Expanding Corporate Profits and Ensuing Challenges Improved competitive