Masaru Hayami: Toward Revitalization of Japan's Economy
Speech by Mr Masaru Hayami, Governor of the Bank of Japan, at the Keizai (Economic) Club, Tokyo,
29 January 2002.
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Introduction
I am grateful to have the opportunity to talk to this meeting. Japan's economy will enter a critical phase
this year to establish a basis for sustainable growth by pushing forward with structural reforms in the
economy and by restoring a sound financial system. Today I would like to express my views frankly
from the standpoint of the central bank on what needs to be done for Japan's economy to revitalize it
in the rather longer term.
I. Economic and Financial Developments in 2001
A. Economic Developments in and outside Japan
First, I would like to look back briefly on economic developments in and outside Japan in 2001, a year
in which Japan and the global economy were in a very severe situation.
When I made a speech last time to this Club in December 2000, I pointed to two downside risks to
Japan's economy that needed careful monitoring: first, developments in overseas economies, the U.S.
economy in particular; and second, the volatile movements in stock markets. What I emphasized was
that due attention should be paid to a possible downswing of the economy arising from these risks
especially when the economy had structural problems and was vulnerable to external shocks.
Unfortunately, these downside risks actually materialized in 2001.
The most notable feature of economic developments in 2001 was a simultaneous slowdown of
economies worldwide against the background of global adjustments in information and
communications technology (ICT)-related industries. And in September 2001, the tragic terrorist
attacks occurred in the United States. The authorities responsible for macroeconomic policy were
compelled to deal with both economic deceleration and the negative shocks to their economies.
The worldwide decline in demand for ICT-related goods caused a significant fall in exports and
production in Japan from early 2001. This led to adjustments in the corporate sector, as seen in a
decrease in corporate profits and business fixed investment. These adjustments then spread to affect
employment and income conditions in the household sector, and recently they have been exerting
downward pressure on private consumption.
However, some positive signs have been observed very recently. Global inventory adjustments in
ICT-related industries have made progress gradually. Accordingly, shipments of semiconductors
worldwide are showing signs of bottoming out, and some semiconductor prices are recovering.
Exports of East Asian countries, which had declined earlier than those of other areas, are starting to
show signs of bottoming out. In financial markets overseas, stock prices and long-term interest rates
generally indicate an expectation of economic recovery in the near future.
It is, however, still uncertain whether the progress of inventory adjustments in ICT-related goods will
be followed by a recovery of final demand overseas. Thus, we need to monitor carefully whether
overseas economies, especially the United States, will recover steadily.
In Japan, weakness in final demand such as business fixed investment and private consumption has
become conspicuous, and the severe adjustment phase will inevitably continue for some time. On the
other hand, conditions for exports are showing some positive signs. In addition, inventory adjustments,
especially those in ICT-related goods, have been making progress gradually. Accordingly, downward
pressure on production arising from inventories is expected to be fading.
Given the positive factors such as the subsiding downward pressure on exports and production
together with the negative factors such as intensified adjustments spreading to the household sector,
Japan's economy will enter a critical phase in the near future in terms of finding a way to recover.
B. Adoption of the New Monetary Easing Framework
Next, I will outline the Bank's conduct of monetary policy since the beginning of last year.
In early 2001, we forecasted that Japan's economy would have to undergo severe adjustments, given
the simultaneous slowdown of economies worldwide.
In addition to the severe economic outlook, we were in a very difficult position in regard to room for
further policy actions. There was almost no room for further rate reduction because the call rate, which
was our operational target, was as low as 0.25 percent at the beginning of 2001 due to the series of
drastic monetary easing measures taken in the 1990s.
In this situation, we adopted a new policy framework for monetary easing in March 2001. We changed
the main operating target from call rates to a quantitative indicator of liquidity, that is, the outstanding
balance of current accounts at the Bank of Japan, and we have substantially increased the balance.
Because this was a very drastic easing measure and was unprecedented in the history of central
banking worldwide, we had to consider various issues very carefully before deciding it. Above all, it
was uncertain whether and how expansion of liquidity provision in a situation where the rate is virtually
zero percent would influence the economy. Needless to say, the mechanism through which such an
expansion affects the economy has not been demonstrated either theoretically or empirically.
It is particularly important to gain public confidence to make monetary policy effective. Public
confidence in economic policy is hard to gain in the short term. First of all, the authorities should
faithfully explain to the public the expected effects and risks of each policy measure to be taken. Then,
people will monitor the effects achieved and how the risks turn out, and verify whether they have been
in line with the authorities' explanation. Public confidence can be gained only through continuous
efforts to fulfil the requirement to be accountable. Thus, the authorities should be careful not to
introduce measures in a piecemeal manner based on the shortsighted idea that "it is better to do
something than nothing."
When the new framework of monetary easing was adopted in March 2001, I believed that the Bank
should continue to faithfully fulfil its duty of accountability. In other words, the Bank should explain the
necessity of entering uncharted territory by taking unprecedented measures given the severe
economic outlook, together with the fact that the effects were uncertain to some extent, and try to gain
the public's understanding.
Monetary policy cannot directly generate demand nor can it be a substitute for measures to advance
structural reforms. Also, its stimulative effects on the economy will be very limited in the quantitative
sense in the situation where interest rates, both on short- and long-term instruments, are at their
lowest possible levels and cannot decline further.
When the Bank decided the new frameworks in March 2001, I believed that the Bank should continue
to make best efforts on its part, and should continue to call strongly for the structural reforms that are
indispensable and also one of the prerequisites to make monetary easing effective. In other words, the
Bank decided to take such drastic and unprecedented easing measures ahead of structural reforms, in
the hope that other measures would follow to advance structural reforms significantly.
The Bank of Japan had already taken easing measures twice in February 2001. Since March 2001,
the Bank has decided on as many as four further easing measures, under the new framework of
monetary easing. In view of further deterioration of the economy and financial conditions, we decided,
in December 2001, to expand the balance of current accounts at the Bank and utilize new financial
instruments such as asset-backed securities as tools for the Bank's market operations and as eligible
collateral.
C. Experiences in the Course of the Unprecedented Monetary Easing
As the Bank has continued its unprecedented monetary easing, it has accumulated experience with
regard to its effects.
A series of monetary easing measures since 2001 has been effective to a certain degree in reducing
short-term interest rates and in alleviating anxiety about liquidity.
The overnight call rate is currently as low as 0.001-0.003 percent. This is lower than the level of
0.02-0.03 percent under the "zero interest rate policy."
Moreover, the Bank's ample provision of funds and its strong commitment in terms of policy duration
that the Bank would continue the new monetary easing framework until the inflation rate registers
stably zero percent or above have led to a decline in longer-term interest rates. For example, the
interest rate on one-year Japanese government securities is also very close to zero, at 0.001 percent
recently.
In the aftermath of the terrorist attacks, liquidity problems did not arise in Tokyo markets, due to the
Bank's ample provision of funds. Also, there was no serious disruption in trading and settlement at the
end of 2001 when concerns over the financial system heightened reflecting the failure of several large
firms. And currently, there is no liquidity shortage in sight as we move toward the end of the fiscal year
in March 2002.
However, expanding the quantity of liquidity provision as seen in the balance of current accounts has
not yet markedly affected economic activity, prices, or people's expectations.
Under the new monetary easing framework, monetary base has expanded drastically by as much as
15 percent or more year on year. This is the largest growth since the hyperinflation period at the first
oil crisis in the 1970s, except for the period when there was the irregular factor of the "Year 2000
Problem." Private banks' lending, however, remained sluggish, and economic growth and prices have
continued to be on a downtrend.
Strong monetary easing and large-scale fiscal spending were employed continuously during the
1990s. Reflecting such monetary easing, monetary base and money stock continued to increase at a
fairly rapid pace compared to the level of economic activity. Japan's economy, however, failed to
return to a sustainable growth path. This clearly demonstrates that monetary easing cannot change
banks' lending attitude, economic activity, and prices when there are various structural problems, such
as the nonperforming-loan (NPL) problem, in the economy.
These experiences under the unprecedented monetary easing highlight how grave Japan's structural
problems are. I believe it is necessary to accept this fact and have a constructive debate about what
should be done to change this situation. Based on such thoughts, the Bank of Japan has been
emphasizing that the primary tasks to be accomplished for revitalization of Japan's economy are
advancing structural reforms in the economy and industry, and restoring the soundness of Japan's
financial system. I now would like to move on to these two issues of structural reforms and the
financial system.
II. Structural Reforms and Japan's Economy
A. Goals of Structural Reforms
Japan and other industrialized countries are facing intense international competition arising from rapid
industrialization of emerging economies such as those in East Asia.
As a country develops and grows wealthier and accordingly the level of people's income rises, it will
constantly be exposed to stronger competition from countries with lower wages. This is a natural
development for industrialized countries, and they must accept it as inevitable challenges. They need
to continue adapting flexibly to change by industrial restructuring and fostering high value-added
industries to lead the economy.
Moreover, if industrialized countries can continue to foster such promising industries, this will bring
about an expanding equilibrium in the global economy through, for example, development of new
markets and establishment of an efficient international division of labor. Japanese manufacturers have
increased the share of production carried out overseas, and this has recently become a matter of
concern, being viewed as a hollowing-out of Japanese industry. However, the share for Japanese
manufacturers stands at around 15 percent, which is lower than U.S. and European manufacturers'
share of around 20-30 percent. Manufacturers' shifts to overseas production could adversely affect
certain regions or industries in the short term. However, we cannot stop firms' moves to utilize an
international division of labor more efficiently amid globalization. Furthermore, these movements could
bring benefits to the economy as a whole, in the medium to long term.
In fact, in the 1990s the United States and Europe achieved fair growth using innovations in
ICT-related areas. I would like to point out that the United States and the United Kingdom had
advanced reforms since the 1980s to realize small and efficient government. The Continental
European countries had also made efforts to address structural reforms toward monetary union.
In contrast, grave problems including the NPL problem had mounted in Japan's economy, in the
course of the emergence of the "bubble" economy of the 1980s and its bursting in the early 1990s,
and Japan fell behind other industrialized countries in dealing with structural problems.
The key to a brighter economic outlook for the medium to long term is whether a sufficient number of
high-productivity industries or projects that can point a direction for the economy will emerge in the
private sector. To revitalize Japan's economy, it is essential to create the conditions where private
initiatives and vigor are fully encouraged.
The Council on Economic and Fiscal Policy, of which I am a member, drafted blueprints of structural
reforms last year, such as the Solid Policy Framework and the Medium-Term Economic and Fiscal
Perspectives. Detailed measures as well as progress in their implementation will be discussed further.
I believe that the most fundamental yardstick to be applied to evaluate each policy measure will be
whether it could work to stimulate private demand.
This year, issues concerning the taxation system and government financial institutions will be
discussed in the council.
In the discussion regarding the tax system, the conventional principles of taxation, that it should be
fair, neutral, and simple, will continue to apply. In addition, new perspectives will be vital in deciding on
its reforms, for example, whether the tax reform can stimulate free and creative economic activity in
the private sector, and whether the new system would comply with globalization of economies and
corporate activities.
Since the beginning of the 1990s, government financial institutions have increased their share in the
total lending to the private sector, especially loans extended to large firms, and it has now reached
around 20 percent. If their share of lending is too large, the market mechanism may not work properly
in the setting of lending rates. Moreover, the developments of capital markets can be held back
because large firms will likely rely on government lending. In vitalizing the economy utilizing the market
mechanism, the reform of government financial institutions is also one of the essential tasks. I think
such reform should be advanced by letting the private sector do what it can do. In this regard, one
reasonable way to do this would be to change the functions of government financial institutions to
focus mainly on guarantee and refinancing.
B. "Pain" Accompanying Structural Reforms
There are those who, while acknowledging the need to undertake structural reforms, ask whether
some policy measures could "alleviate the pain" accompanying structural reforms in the short term.
We fully understand the background to such opinions given the current severe economic situation and
the negative impact of structural reforms in the short term.
Many people talk about "alleviating the pain of structural reforms," but the meaning is often unclear
because it gives scope for various interpretations. It is sometimes used to mean stopping structural
reforms or simply postponing facing the "pain."
In evaluating various policy measures proposed for alleviating the "pain" of structural reforms, I feel it
is necessary to examine them from the viewpoint of whether they are consistent with the ideal
socioeconomy to be achieved by structural reforms.
For example, in the process of consolidating firms and restoring the soundness of Japan's financial
system, bank lending is likely to decrease and lending spreads will expand reflecting credit risk. Under
these circumstances, calls for financial institutions to increase their lending volumes are likely to
emerge. We also sometimes hear extreme requests to the central bank to lend directly to firms.
However, in the process of restoring the soundness of Japan's banking system, lending rates must be
adjusted to appropriate levels according to the risks on loans, and loans to inefficient firms must be
reduced. Needless to say, any contraction of corporate financing must not go so far as to make it
difficult for viable firms to obtain financing. In viewing these points, I believe the following measures
are very important. First, it is necessary to encourage the entry of new firms into the market as well as
increase the pace of industrial restructuring, which will be accompanied by withdrawal of nonviable
firms from the market. Second, it is also useful to foster new ways of financial intermediation, in
addition to indirect financing. For this reason, the Bank of Japan is making efforts to develop financial
markets to improve funds intermediation by utilizing new financial instruments, such as asset-backed
securities, as tools for market operations and as eligible collateral.
On the other hand, direct financing of firms by a central bank is an apparent deviation from its
designated role. Moreover, such operations are not consistent with the objective of structural reforms,
which is reviewing financing through government financial institutions in order to ensure full utilization
of the market mechanism and private initiatives.
As a measure to alleviate the "pain" of structural reforms, there are also calls for artificially controlling
the exchange rate of the yen so that it depreciates.
Since the end of December 2001, the yen has depreciated to around 130-135 yen against the U.S.
dollar. In the short term, such movements of the exchange rate reflect the view of market participants
who are increasingly expecting a recovery of the U.S. economy while becoming more concerned
about the structural problems of Japan's economy. One concern is that some insist that the currency
authority should cause the yen to depreciate by artificial means. However, it is not at all feasible to
control exchange rates artificially where the flow of foreign exchange transactions and capital
movements are liberalized. Moreover, if Japan with its large economy were to artificially lower the
value of its currency in order to resolve its own economic problems, the credibility overseas of its
overall economic policies and currency could be damaged.
Foreign exchange rates reflect the market's evaluations of the economic performance of each country
in the medium or long term. If Japan were not able to foster high value-added industries, or if foreign
exchange markets believed Japan unable to do so, market forces would work in the direction of yen
depreciation. However, this means that economic adjustments would take place by diminishing
Japan's purchasing power. Structural reforms are not at all intended to cause adjustments in this
pessimistic way.
It is therefore desirable that foreign exchange rates move stably reflecting fundamentals of the
economy. A depreciation of the yen will not solve the problems of Japan's economy that must be
overcome.
We have sometimes been asked whether there is a way to stop the downtrend of prices during the
structural reforms. We have also received suggestions that prices should be made to increase so that
structural reforms can be implemented smoothly.
First of all, I want to stress that we have already made a strong commitment to continue the current
framework of monetary easing until the inflation rate registers stably zero percent or above, and we
have been implementing drastic easing measures unprecedented in the history of central banking.
Therefore, criticism that the Bank is tolerating price falls or deflation is a complete misunderstanding.
At the same time, the basic relationships between structural reforms and prices must be correctly
understood. The recent price decline is attributable to various factors such as technological innovation,
deregulation, and an increase in low-priced imports. But above all, the major factor is that Japan's
economy was not able to achieve a full-scale recovery in the 1990s and that the negative output gap
expanded due to lack of demand.
Needless to say, there is a strong correlation between economic activity and prices. First, the level of
economic activity and the balance of supply and demand change, and then prices respond to these
changes. In short, prices rise after economic recovery begins, and not vice versa.
Structural reforms aim to directly tackle the problems that have long prevented a sustained growth of
the economy and improvement in productivity, and thus boost private demand. Needless to say,
structural reforms are chosen and supported by the people, and they are indispensable for Japan's
economy to return to a sustainable growth path in the medium to long term. In the short term,
however, downward pressures on prices are inevitable if the economy must endure a low growth rate
temporarily in the course of structural reforms and fiscal consolidation, because the negative output
gap would widen as a result. An increase in prices, if it were the sole objective, could be achieved by a
significant fiscal expansion that could tighten in the balance of supply and demand. However, this
would be inconsistent with the objective of structural reforms.
It may seem contradictory, but I believe that the most effective and credible prescription to alleviate the
pain accompanying structural reforms is to steadily implement reform measures and to gain the
confidence of economic entities and the markets regarding the objective and the direction of the
reforms.
If, by undertaking solid structural reform measures, households' concerns about future pension and
social security systems are reduced, and if firms foresee an increase in productivity in the future,
spending activities of firms and households will be stimulated. And furthermore, if Japan's efforts in
tackling structural reforms are received favorably by financial markets, we can expect some positive
effects of structural reforms to appear much earlier, for example, via a rise in Japanese stock prices.
For this reason, I attach great importance to clearly explaining the schedules of concrete reform
measures and visibly demonstrating their expected effects so that people can have confidence in
them.
III. Issues concerning Japan's Financial System
A. Current Condition of Japan's Financial System
I would like to move on to discuss Japan's financial system, another important part of structural reform
of Japan's economy.
First, let us take a look at overall stock prices. Until September 11 last year, the U.S. and Japanese
stock markets had trended the same way. However, Japanese stocks have become weaker since
October, and the two markets started to trend in a different direction. In the meantime, the structure of
stock markets has been changing. The presence of foreign investors in Japanese stock markets has
been increasing. For example, the volume of stock transactions by foreign investors has been
increasing year on year at the Tokyo Stock Exchange (TSE), while the daily turnover of transactions at
the TSE has maintained a considerable amount of some 600 to 800 million shares. Amid weakening
stock prices and the changing structure of stock markets, I hope that Japanese stock markets will
become more transparent and fair through various measures such as the recently tightened
regulations on short sales of stocks.
Now, if we take a look at stock prices by industry, we see a clear trend. While stock prices of firms in
electrical appliances and transportation equipment industries are rising, stock prices of those in
construction, real estate, and banking industries are falling. The trend shows that market participants
are taking a harsher view of Japan's financial system.
Three factors seem to determine the weakness of bank stocks. First, the banking sector is suffering
from the NPL problem. Second, there has been a series of failures of borrower firms and there are
concerns that such failures might continue. It should also be noted that more time is required for
restructuring of borrower firms amid business reorganization in the banking industries. And third,
unwinding of cross-shareholding is progressing due to introduction of mark-to-market accounting.
The biggest concern is the NPL problem of Japanese financial institutions, which places a heavy
burden on Japan's economy overall.
Japanese financial institutions have been making efforts in various ways to resolve this problem. In the
past decade, many have disposed of an amount of NPLs exceeding their annual operating profits
each year. However, the amount outstanding of NPLs has not declined as the amount of new NPLs
has been more than that of ones disposed of.
For some time after the bursting of the "bubble," a large majority of NPLs were loans extended to
nonbanks and firms in the real estate and construction industries. Recently, however, NPLs are
increasingly emerging from loans extended to firms in service industries such as retail, as well as
some in manufacturing industries. It seems that new NPLs are emerging in the industries challenged
by structural adjustments.
The emergence of NPLs implies progress in structural adjustments. In this regard, not only financial
institutions, the lenders, but also borrower firms are required to implement major reforms of their
business management for the resolution of the NPL problem.
B. Financial Institutions' Measures to Address the NPL Problem
The NPL problem, which is related to both financial institutions and borrowers, should be addressed
primarily by the former. In fact, large banks announced the major steps they would take to achieve the
projected results of disposal of NPLs for fiscal 2001 in autumn 2001 when announcing their financial
results for the first half of fiscal 2001.
The major steps include (1) larger disposal of NPLs than planned for before the start of fiscal 2001, (2)
further cost-cutting, (3) review of their lending conditions, especially interest rates, in light of different
credit qualities of borrowers, and (4) improvement of profitability by way of these steps. These steps
are highly welcome, and I hope that they will be elaborated into concrete measures and implemented
promptly so that the markets' confidence in Japanese financial institutions will be restored.
In the last phase of the resolution of the NPL problem, the removal of NPLs from financial institutions'
balance sheets is necessary in addition to loan-loss provisioning.
Financial institutions are increasingly promoting liquidation of their loans by selling them to third parties
while instituting reconstruction proceedings against distressed firms under the Civil Rehabilitation Law.
For example, some Japanese banks are making use of the "investment funds for corporate
reconstruction," which also includes foreign investment funds, for financial resources and expertise on
how to liquidate their NPLs. Moreover, it is expected that methods that have not been common in
Japan, such as debt equity swaps, will be used. It is also expected that the Resolution and Collection
Corporation (RCC) will be utilized more, as its functions to reconstruct firms have been strengthened,
and its terms and conditions for purchases of loans have been made more flexible through recent
amendments to the Financial Reconstruction Law.
I hope that the use of various measures will speed up the disposal of NPLs.
There is a view that if banks were to speed up their disposal of NPLs too much, the economy could be
negatively affected. To some extent, NPLs are simply the result of an economic slump. But, as I
mentioned earlier, many are loans extended to firms in industries facing structural adjustments. If
banks postpone the disposal of their NPLs, this could delay the structural adjustments, and ultimately
delay the revitalization of the overall economy. Further, the resolution of the NPL problem, which has
been placing a burden on financial institutions' business, could have great significance in that it would
contribute to restoring the financial intermediary function, an essential part of the infrastructure of the
economy. If, however, the disposal of NPLs is delayed, this might threaten the stability of the entire
financial system through a further decline in markets' confidence in the soundness of Japanese banks.
C. The Importance of Strengthening Profitability
Next, I would like to share with you another important task that Japanese financial institutions are
working at, that of improving their profitability. As financial institutions have been required to dispose of
NPLs amounting to more than their annual operating profits, their financial strength has been
weakened. To recover their financial strength, the disposal of NPLs--a legacy of the past--alone is not
sufficient. They need to improve their profitability.
To improve financial institutions' profitability in the long run, the financial institutions themselves need
to establish new business models. I understand that this is easier said than done, but there seems to
be room for further improvement. Financial institutions should first identify areas where they have an
advantage over other competitors, and develop a business strategy taking full advantage of their
strong areas, and reallocate their business resources.
Business consolidation and reorganization through various measures such as mergers, establishment
of bank holding companies, and business alliances have become common in the financial sector in the
past few years. Business reorganization is taking place in various different forms, such as mergers
between financial institutions beyond the confines of their own corporate groups, integration of trust
bank business and that of securities business within financial groups, and plans for super-regional
banks. The most important thing is for financial institutions to find ways to take full advantage of
business reorganization to reform their business management.
I hope that financial institutions' efforts to improve their profitability will contribute to pushing forward
both the disposal of NPLs and the corporate rehabilitation, and to revitalizing the financial system. The
progress in NPL disposal, corporate rehabilitation, and financial system revitalization will bring about
positive synergy effects, such that markets' confidence in financial institutions will be restored, which in
turn will have positive effects on stock prices.
It cannot be denied, however, that it will take time for measures implemented by financial institutions to
have positive effects.
D. Injection of Public Funds and the Ending of the Blanket Guarantee on Bank Deposits
As the disposal of NPLs progresses, we need to prepare for an emergency where concerns about the
stability of the financial system as a whole are raised despite the efforts made by financial institutions.
The amended Deposit Insurance Law, which came into effect in April 2001, states that in such an
event, the Prime Minister may, following deliberation by the Council for Financial Crisis, acknowledge
the necessity of injecting public funds.
It is necessary to expeditiously advance the resolution process of financial institutions that cannot
reconstruct their business.
In addition to the injection of public funds by the Government, if it is necessary from the viewpoint of
maintaining the stability of the financial system, the Bank will for its part fulfil its responsibility of
providing liquidity as the lender of last resort, which is one of its fundamental roles.
As the last topic on the financial system, I would like to comment on the ending of the blanket
guarantee on bank deposits scheduled for the end of this March.
There is little time left before the ending of the blanket guarantee on bank deposits. I hope that each
financial institution will further accelerate the resolution of various business man